Corporate M&A 2024 Comparisons

The 2024 M&A market in Puerto Rico, when compared to the 2023 market, should experience an increase in transactional activity. Throughout the aftermath of the COVID-19 pandemic and other economic factors, M&A activity in Puerto Rico has continued at a steady pace throughout multiple industries including tourism and hospitality, automobile dealerships, payment processing, healthcare, entertainment, technology, construction and insurance. We expect that, as long as employment and economic conditions continue to improve in Puerto Rico, and the US economy does not go into a recession, transaction volumes in the local M&A market should continue on an upward trajectory.

The trend caused by the proliferation of local private equity funds under Act 60 of 2019 (formally under Act 185 of 2014, known as the Private Equity Funds Act, as it is now codified in Act 60 of 2019, as amended, known as the Puerto Rico Incentives Code) should continue to increase the pool of investable capital ready to be deployed for the acquisition of Puerto Rico businesses. In addition, the Puerto Rico Incentives Code codified local tax decrees, incentives, exemptions, subsidies, reimbursements and other tax benefits. As a direct effect, new players have entered into the Puerto Rico M&A market and there has been a notable increase in the volume of transactions.

On the other hand, as happens with growing economies, the distress associated with contracting economies yields significant M&A activity. Although there is no publicly available data regarding M&A activity in Puerto Rico, the sale in bulk by local financial institutions of distressed property loan portfolios, repossessed developments and residential and commercial properties has significantly reduced in transactional volume. However, if the US economy experiences a hard landing and goes into a recession, the local economy could experience a certain level of distress and this trend could reverse.

The main industries that could potentially continue to witness significant M&A activity in Puerto Rico are tourism and hospitality, export of services and goods, manufacturing, construction, renewable energy, automobile dealerships, payment processing, pharmaceutical and healthcare, agriculture and finance.

It is important to note that the vast majority of companies located in Puerto Rico are privately held. Thus, the overwhelming majority of M&A transactions in Puerto Rico involve the purchase and sale or consolidation of privately held companies.

The main acquisition mechanisms available are:

• a stock or ownership interest purchase;
• an asset purchase; or
• a merger or consolidation.

In a stock or membership interest purchase, the purchaser acquires the target’s outstanding equity interest from its owners by means of an equity purchase agreement to be executed by and between the purchaser and the target’s owners. A purchaser could also acquire equity interest from the same target entity through a subscription agreement if the target entity will make an additional issuance of equity. Generally, an equity purchase requires the consent of the target’s individual owners and the purchaser’s governing body. In spite of the above, in the event that the purchaser holds at least 90% of the target’s interest, it may undertake a “short-form merger”. In such a merger, the parent company is able to merge the target into the parent without the approval of the target’s governing body, the parent’s equity holders or the target’s minority owners.

In an asset purchase, the purchaser generally acquires all or substantially all of the target’s assets and, in some cases, it may also assume certain liabilities of the target company as part of the consideration. This transaction structure allows the parties to pick and choose the particular assets (and corresponding liabilities) that will be acquired (or assumed) by the purchaser. In the event that the target is selling all or substantially all of its assets, as a general rule both the governing body and the majority stakeholders of the target entity must approve the transaction. As for the purchaser in an asset transaction, it is advisable that, to limit the risks that may be associated with the acquired assets and liabilities, the purchaser organise a subsidiary to acquire the assets and assume any liabilities being transferred.

As to mergers and consolidations, the transaction will depend on the type of merger or consolidation agreement or reorganisation plan. In a triangular merger, the target is merged into a new entity (organised solely for the purposes of the underlying transaction) resulting in the survival of the new entity as a subsidiary of the purchaser. Nevertheless, under certain circumstances the target could be the surviving entity. The alternative structure is often referred to as a “reverse triangular merger” and it is commonly used when the target has contracts, permits, licences or tax attributes that cannot be transferred to a third party.

One of the core matters in an M&A practice is identifying how to structure a transaction in the way that is most beneficial for the parties involved. The final structure of a transaction will depend on multiple factors that include business, financial, legal, regulatory and tax considerations.

Puerto Rico, as an unincorporated territory of the USA, enjoys US constitutional, legal, financial and regulatory protection. Thus, almost all US federal laws and regulations, including federal securities laws, apply to Puerto Rico.

The Puerto Rico General Corporations Act of 2009, as amended (the General Corporations Act), provides the substantive corporate law. It is the principal and most comprehensive statute in connection with the constitution, governance and dissolution of corporate entities and limited liability companies in Puerto Rico. The General Corporations Act is modelled on the Delaware General Corporations Act, and the Puerto Rico Supreme Court has determined that the decisions of Delaware courts in connection with the interpretation of the Delaware General Corporations Act are to be followed in Puerto Rico courts.

Corporations, limited liability companies and partnerships, among other types of entities, are incorporated, organised or authorised to do business in Puerto Rico with the Department of State of Puerto Rico. The Registry of Corporations and Entities of the Department of State of Puerto Rico offers a range of online services including a searchable data base of registered legal entities, the organisation or incorporation of new legal entities, certificates of good standing, certificates of existence, amendments to the public information contained in the registry, the dissolutions of legal entities, the submission of annual reports, the payment of fees or request for extensions, among other transactions.

When an M&A transaction involves financial institutions, the Commissioner of Financial Institutions of Puerto Rico has to evaluate and approve the merger or consolidation. If the transaction involves banks, the appropriate federal regulators will also have to evaluate and approve such transaction.

Similarly, the Puerto Rico Insurance Commissioner must evaluate and approve the merger or consolidation of insurance companies organised under the Puerto Rico Insurance Code. The Puerto Rico Insurance Code further provides that insurance companies may only merge or consolidate with other insurance companies of the same classification.

If a party to an M&A transaction holds a tax incentive grant, certain notices or consents must also be obtained from the Office of Incentives for Businesses in Puerto Rico (OIBPR), which is ascribed to the Department of Economic Development and Commerce.

As an unincorporated territory of the USA, Puerto Rico enjoys US constitutional, legal, financial and regulatory protection, and almost all US federal laws and regulations apply to Puerto Rico. Thus, the Foreign Investment and National Security Act 2007 and the Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act 1988 both apply to Puerto Rico. These statutes grant the Committee on Foreign Investment in the United States the authority to investigate and block transactions that may threaten the national security of the USA.

The Puerto Rico Monopoly Act (the Monopoly Act) governs, from a state law perspective, the antitrust considerations that could arise in connection with the purchase or sale of an ongoing concern, expressly prohibiting business combinations that result in an unreasonable restraint of trade or commerce in Puerto Rico. The Monopoly Act does not require that the parties to a transaction obtain the prior approval of the Office of Monopoly Affairs of the Puerto Rico Department of Justice, but it may issue advisory opinions if voluntarily requested by the parties. While a negative advisory opinion does not prohibit the consummation of the proposed transaction, a favourable advisory opinion provides a certain degree of immunity if the transaction is closed under the terms and conditions previously disclosed to the Office.

The Clayton Act, as amended by the Hart-Scott-Rodino Antitrust Improvements Act 1976 (the HSR Act), also applies to Puerto Rico. The HRS Act and applicable regulation prohibits M&A transactions that may substantially lessen competition or tend to create a monopoly. The HSR Act grants to the Federal Trade Commission and the federal Department of Justice the power to review and object to certain transactions that, given the size of the transaction and/or the size of the parties involved, may have antitrust implications.

The HSR Act requires parties that meet certain transaction or parties size criteria to file pre-merger notifications with both the Federal Trade Commission and the Department of Justice Antitrust Division prior to the consummation of the transaction (unless otherwise exempted under the HSR Act and its regulation). As of 6 March 2024, if a transaction is in excess of USD119.5 million, it must comply with the HSR Act if the “size of parties” test is met, which is met if one of the parties involved in the transaction has USD239 million or more in annual net sales or total assets and the other party has USD23.9 million or more in net annual sales or total assets. Further, if, as a result of the transaction, the purchaser acquires or holds voting securities or assets of the seller that are valued in excess of USD478 million, the “size of transaction” test is met and the parties will have to comply with the requirements of the HSR Act, since acquisitions in excess of such amount are reportable regardless of the size of the parties unless an exemption applies.

One of the most significant legislations with regard to labour matters in connection with M&A transactions in Puerto Rico is Act 80 of 1976, as amended (Act 80). Act 80, which applies to employees hired for an unfixed period of time, provides that employees who have approved the statutory automatic probationary period and are discharged without just cause, as defined by Act 80, have a right to severance pay based on a formula under Act 80 that takes into account the duration of their employment and the highest salary received by the employee during the prior three years. Thus, within the context of the purchase of an ongoing concern, if the purchaser does not retain all of the employees of the target entity, the purchaser is required by Act 80 to retain from the purchase price an amount equivalent to the severance payments to the employees who are not hired by the purchaser.

Act 80 also provides that if the purchaser hires all or some of the employees of the target entity, the purchaser must recognise to the retained employees the seniority of their employment and years of service with the target and, in the event of any termination without just cause after the closing of the transaction, the purchaser will be responsible for the severance payment taking in consideration the years of service of the employee with the target acquired entity.

In addition, the Puerto Rico Supreme Court has adopted the successor employer doctrine, which provides that if the purchaser of assets retains some or all of the target company’s employees and, subject to certain factors, it is deemed a successor employer, therefore the purchaser, among other events:

• could be responsible for any discriminatory termination of an employee by the target;
• must comply with prior collective bargaining agreements; and
• could be liable for illicit employment practices undertaken by the target.

In addition, depending on the structure of the transaction and the specific voluntary benefits offered by the target to its employees, purchasers may also be required to comply with the provisions of the Employee Retirement Income Security Act, a US federal law which governs private industry employee pension and welfare plans.

Puerto Rico is an unincorporated territory of the USA and enjoys US constitutional, legal, financial and regulatory protection. As such, the Foreign Investment and National Security Act of 2007 and the Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act of 1988 apply. These statutes grant the Committee on Foreign Investment in the United States the authority to investigate and block transactions that may threaten the national security of the USA.

A significant legal development impacting on the local M&A market is the enactment of Act 60 of 2019, as amended, known as the Puerto Rico Incentives Code. In general, the Puerto Rico Incentives Code codified local tax incentive legislation pertaining to decrees, incentives, exemptions, subsidies, reimbursements and other tax benefits. In addition, Act 60 of 2019 (formally under Act 185 of 2014, known as the Private Equity Funds Act, as now codified in Act 60 of 2019), establishes the framework for the creation and taxation benefits of two types of private equity funds in Puerto Rico. Among other things, private equity funds must invest at least 80% of their paid-in capital in Puerto Rico private businesses.

Another significant legal development in Puerto Rico was the enactment of Act 55 of 2020, as amended, that established the new Civil Code of Puerto Rico of 2020, and repealed the Civil Code of Puerto Rico of 1930. Act 55 of 2020 provides that the Civil Code of Puerto Rico, as amended, is the main source of private law in Puerto Rico. The Civil Code of Puerto Rico of 2020 contains a general set of norms that govern multiple matters including the basic principles of contractual law.

Outside of the statutes mentioned above that may have an impact on general M&A activity, in recent years there have been no other significant changes to local laws that may have a direct or material impact on M&A activity in Puerto Rico, nor is there, at the time of writing, any pending legislation that could impact on such activity in the coming months.

Given the private nature of most businesses in Puerto Rico, it is very difficult, if not nearly impossible, to acquire a stake in a target corporation or limited liability company prior to launching an offer to acquire it. The general practice is to approach the owners, make an offer and hopefully generate sufficient interest to commence negotiations for the acquisition of the target. Nonetheless, if the target is one of the very few Puerto Rico-based companies that currently trade on US stock exchanges, a stake could be acquired prior to launching an offer via the acquisition of its publicly traded stock.

Unless the target is a publicly traded corporation based in Puerto Rico, which would be subject to the disclosure requirements under the federal securities laws, there is no material shareholding threshold disclosure requirement under Puerto Rico laws. When the target is a publicly traded corporation, any person who acquires a beneficial ownership of more than 5% of the outstanding shares with equity voting rights is required by the federal securities laws to comply with Section 13-d of the Securities Exchange Act 1934 by filing Form-13D with the SEC. Note that, besides the outright ownership of the shares, beneficial ownership is attributed to persons who have the right to acquire these shares within a period of 60 days via other types of securities, such as call options.

There are no statutory requirements in Puerto Rico concerning ownership thresholds for privately held companies. Thus, Puerto Rico companies do not engage in the practice of introducing different reporting thresholds in the articles of incorporation, by-laws or elsewhere other than those applicable to publicly traded companies under federal securities laws.

Under federal and Puerto Rico securities laws, dealing in derivatives is allowed. Notwithstanding this, the use of derivative securities or instruments is not common among Puerto Rico privately held companies and their use is very limited and confined to sophisticated parties.

As mentioned in 4.2 Material Shareholding Disclosure Threshold, under Section 13-d of the Securities Exchange Act 1934, beneficial ownership of voting stock for triggering the 5% disclosure requirement includes the right to own such shares via derivatives. Additionally, depending on the size of the transaction and the parties, disclosure to the Federal Trade Commission and the federal Department of Justice under the HSR Act may be required.

Generally, in Puerto Rico, the shareholders do not have to publicly disclose the purpose of a proposed acquisition or their intention regarding the control of a private corporation. Nevertheless, if the target is a banking institution or an insurance company, the purchaser will be required to disclose additional information concerning the transaction to the Office of the Commissioner of Financial Institutions or to the Office of the Commissioner of Insurance.

There are no statutory disclosure triggers applicable to privately held companies in Puerto Rico. However, as discussed in 2.2 Primary Regulators, insurance companies contemplating a transaction must disclose their plans and obtain the approval of the Commissioner of Insurance of Puerto Rico. Financial institutions must also disclose their plans and obtain the approval of the Commissioner of Financial Institutions of Puerto Rico prior to closing, and if a party to an M&A transaction holds a tax incentive grant, certain notices or consents must also be obtained from the OIBPR which is ascribed to the Department of Economic Development and Commerce. As a general rule, these entities should disclose the transaction following the execution of a non-binding letter of intent.

If the transaction is a merger or consolidation, the General Corporations Act requires that the parties involved in such a transaction file the corresponding merger or consolidation agreement with the Puerto Rico Department of State. The parties may, however, elect to file a certificate containing the information specified in 7.4 Transaction Documents.

In respect of federal laws, depending on the size of the transaction and the parties, disclosure to the Federal Trade Commission and the federal Department of Justice under the HSR Act may be required. With regard to Puerto Rico’s publicly traded companies, there are no statutory requirements regarding deal disclosures other than the requirements under federal securities laws and regulations.

There are no general statutory disclosure triggers applicable to privately held companies in Puerto Rico. For specific transactions that require certain disclosure, the law or regulation that require such disclosure will establish the timing in which said disclosure must be provided.

The scope of the due diligence review will depend on the complexity of the transaction and the target company’s corporate structure and operations. A comprehensive legal due diligence review will include an investigation and analysis of the target company’s business operations, corporate governance, material contracts and agreements, real estate, employee matters, labour or litigation disputes, tax structure, tax filings and compliance, environmental licences and permits, liabilities and intellectual property, as required.

As indicated above, the vast majority of M&A transactions in Puerto Rico involve privately held companies. A comprehensive due diligence review of the target company is required for the purchaser to validate its valuation of the business and its structure for the transaction, to assess particular risks and to ascertain the viability of the proposed deal.

The COVID-19 pandemic has modified the scope of the due diligence proceedings to include:

• the review of loans received by target companies under special programmes created as part of pandemic recovery efforts and the operations of the target companies to understand the ability of target to request forgiveness of the loans and how a change in control may affect such forgiveness; and
• compliance with health and safety protocols required under certain laws, regulations and executive orders.

On a related note, the pandemic has impacted the timing of the due diligence proceedings, mainly due to the effect of remote work and the access to information responsive to due diligence requests.

Given the limited number of publicly traded companies in Puerto Rico, standstill agreements are not seen in local M&A transactions.

However, exclusivity provisions are fairly common in local M&A transactions. The purpose of these provisions is to prevent a target company from seeking additional purchasers after it has entered into a non-binding letter of intent or has agreed to be acquired by the purchaser. A typical exclusivity provision prohibits a target company, its owners and related parties from engaging in the solicitation of other acquisition offers, providing information or engaging in discussions with other potential purchasers during the due diligence process and up until the acquisition closes or negotiations are terminated.

Tender offers are issued in the context of publicly traded companies and thus are not usually seen in Puerto Rico. The overwhelming majority of M&A transactions in Puerto Rico involve the purchase and sale or consolidation of privately held companies. The definitive agreements generally are stock or membership interest purchase agreements, subscription agreements, asset purchase agreements, or merger or consolidation agreements.

The due diligence review is generally a transaction’s most time-consuming phase. The investigation and assessment of areas such as taxation and labour require an in-depth review of company records, given Puerto Rico’s complex tax and labour laws and regulations. Although each transaction is inherently different, purchasers and vendors can typically expect the whole process from initial term sheet to closing to take anywhere from two to eight months. In larger, complex and multiparty transactions, the process may exceed the eight-month mark. Government-mandated lockdowns and remote work delayed certain deal-closing processes during the COVID-19 pandemic, making it more difficult to obtain certain information and documentation requested as part of the due diligence process. This has significantly improved as a result of easing of regulations.

There are no mandatory offer thresholds under Puerto Rico law. However, as with most US jurisdictions, shareholders do have statutory appraisal rights that they may enforce in local courts when they are “squeezed out” as part of a merger. In the event that certain statutory requirements are met, a court of competent jurisdiction will determine whether the price per share received by a dissenting shareholder is fair in light of the circumstances.

Cash is the most typical form of consideration, followed by equity, given that many of the transactions in Puerto Rico involve privately held companies with valuations below USD50 million.

The tools most commonly used in this jurisdiction to bridge the gap between the parties when there is valuation uncertainty are seller financing, earn-outs and structuring the transaction to make it more tax-efficient for the seller.

Due to the private nature of companies in Puerto Rico, local transactions are typically negotiated and not hostile in nature. Hostile acquisitions are only possible in the context of publicly traded companies, and Puerto Rico has only a few publicly traded companies. As discussed, there are no local regulations addressing takeovers of privately held companies other than the appraisal rights that dissenting shareholders may have.

Given that tender offers are made in the context of publicly traded companies, they are not usually used in Puerto Rico, and there are no usual minimum acceptance conditions for tender offers.

There is no impediment to making business combinations conditional on the bidder obtaining financing. Therefore, a business combination or transaction may be subject to a financing contingency.

Typically, when purchasers wish to lock down a potential transaction, they may execute a term sheet or letter of intent that is partially binding on the parties. Typical binding provisions may include:

• exclusivity provisions whereby sellers may not look elsewhere within a certain period of time;
• break-up fees and expense reimbursement if sellers fail to close;
• non-solicitation provisions; and/or
• non-disclosure provisions.

Match rights are not generally used in this jurisdiction but are sometimes requested and many times rejected. Force-the-vote provisions are not well known in Puerto Rico.

There have been no changes to the regulatory environment that have impacted the length of interim periods.

Purchasers that acquire less than total ownership in a target company typically require the following rights:

• drag-along rights whereby all equity holders are forced to sell their holdings in the target company pursuant to the affirmative vote of a predetermined threshold;
• restrictions on transfers of equity, which can be absolute or subject to a right of first refusal;
• reserved board seats to be filled only by persons appointed by the purchaser;
• reserved approval rights for material decisions – eg, amendments to charter documents, asset sales, dividends or future offerings of securities;
• pre-emptive rights of subscription for any future securities offerings by the target company; and
• non-compete and non-solicitation provisions.

Shareholders may vote by proxy in Puerto Rico, but the term of such proxies is limited to three years unless the proxy expressly provides for a longer term.

Local statutes permit a company in a merger to pay any particular equity holders in cash in lieu of equity and therefore be effectively squeezed out. If the purchaser holds at least 90% of the equity with voting rights, it may perform a short-form merger, which only requires the approval of the purchaser’s governing body and avoids the requirement for the equity holder’s approval.

It is not common to obtain irrevocable commitments from principal shareholders. Usually, the parties enter into a non-binding letter of intent, which does not impose the obligation to close the transaction upon principal shareholders. However, it would include no-shop provisions and/or break-up fees that could be triggered if the seller were to terminate negotiations due to receiving a better offer.

Under Puerto Rico law, there are no statutory requirements for privately held companies to publicly disclose a bid for the acquisition of another privately held company or to publicly produce and disclose financial statements (generally prepared pursuant to generally accepted accounting principles – GAAP) for an M&A transaction. Notwithstanding, for a merger or consolidation transaction to be effective, the merger or consolidation agreement or a certificate of merger must be filed with the Puerto Rico Department of State.

Similarly, there is no statutory requirement to publicly disclose the issue of shares in a business combination transaction. Nevertheless, according to the General Corporations Act, if an acquiring corporation issues common shares exceeding 20% of the amount of common shares outstanding before the effective date of the acquisition or merger, this acquisition or merger will require the approval of the shareholders of the surviving company.

Given the fact that most M&A transactions are executed among private companies, there are no applicable statutory requirements for the bidders to produce or disclose financial statements to the general public. Financial statements, when prepared, are generally prepared pursuant to GAAP.

The General Corporations Act requires that the parties involved in a merger or consolidation transaction file the corresponding merger or consolidation agreement or plan with the Puerto Rico Department of State. The parties may, however, elect to file a certificate containing the following information instead:

• whether the transaction is a merger or a consolidation;
• the names, jurisdictions of incorporation or organisation, and the registry numbers of the constituent companies;
• certification that the constituent companies have adopted a merger or consolidation agreement pursuant to the General Corporations Act;
• the name of the surviving or resulting company;
• a description of the changes or amendments to the articles of incorporation or articles of organisation;
• the address of the surviving company where the merger or consolidation agreement is available; and
• an assurance that the surviving entity will provide, free of charge, a copy of the agreement to the equity holders.

The General Corporations Act is based on the Delaware General Corporations Act and, substantially, all theories of corporate doctrine adopted by Delaware courts have been adopted or are considered highly persuasive in Puerto Rico. This includes the fiduciary duties of care and loyalty owed by directors and officers to the corporation and to its shareholders.

Note that the duties of care and loyalty have been expressly included in the General Corporations Act and that they also apply to managing members, managers and other officers of limited liability companies. The General Corporations Act also states that, besides directors and officers, the duty of loyalty applies to majority shareholders in transactions that represent a conflict of interest, thus providing an additional layer of protection to minority shareholders.

In general terms, the duty of care requires that directors and officers exercise their duties in a prudent and diligent manner, and with the same degree of attention and care as a competent and responsible director or officer under similar circumstances would act. In a merger or acquisition transaction, directors need to be well informed of all the material terms of the transaction and, if they are not familiar with them, they have the duty to make the necessary enquiries and become informed prior to making a decision. A corporation may limit or eliminate, via its certificate of incorporation, the monetary liability of directors or managers for duty of care violations.

On the other hand, under the General Corporations Act, the duty of loyalty requires that directors, officers and majority shareholders act in the best interest of the corporation and its shareholders, and that they should not promote their own personal interest at the expense of the corporation’s interests. Complying with the duty of loyalty requires that directors act in good faith and in an honest and reasonable manner. Contrary to the duty of care, liability for a violation of the duty of loyalty cannot be limited or eliminated via the certificate of incorporation or an operating agreement.

Although special committees are not generally constituted to evaluate a potential transaction, there are certain circumstances in which they might be advisable. Special committees are formed when a director or a majority shareholder is on both sides of the proposed transaction or has other personal interests in the transaction that could cause a conflict of interest and possibly an enhanced standard of judicial scrutiny of the transaction if it is challenged in court.

The business judgement rule establishes a rebuttable presumption that when a board of directors or an officer makes a decision, it makes it in good faith, on an informed basis and with the honest belief that the decision was in the best interest of the corporation and its shareholders. The business judgement rule doctrine states that if there is any reasonable commercial basis for a decision, directors will not be held liable for mere judgement errors even if those errors cause unfavourable results to the corporation. The rule does not apply to, and does not protect, directors or officers for illegal acts, ultra vires acts, fraudulent acts or acts that involve gross negligence, wilful misconduct or a clear conflict of interest.

Delaware jurisprudence, which is highly persuasive in Puerto Rico, has established the following criteria to determine whether the business judgement rule is preserved:

• the director or officer has no personal interest in the subject matter it is deciding;
• the director or officer is sufficiently informed regarding the matter; and
• the decision was made in good faith and rationally, and it was taken for the benefit of the corporation.

When a director or officer has a conflict of interest, courts will use an “entire fairness” standard of review pursuant to which the directors and/or officers must prove that the decision was taken with the “utmost good faith” and that the decision is “inherently fair” to the shareholders. Under this standard of review, the directors and/or officers must show that the transaction was the result of “fair dealing” and that a “fair price” was obtained.

Although Delaware courts have developed another standard of review called the “intermediate standard of review”, which is applied when a board of directors uses defence mechanisms such as a “poison pill” to prevent a hostile acquisition, this review has not yet been adopted by Puerto Rico courts. Under the intermediate standard, courts evaluate the actions taken by the board of directors and the process for taking those actions. The directors must show that the decisions taken by them are reasonable and not merely rational under the business judgement rule.

Generally, companies that are considering an M&A transaction engage outside counsel and financial advisers. Depending on a company’s particular industry, hiring other specialised consultants may be advisable.

Independent counsel for the purchaser is generally responsible for the preparation of the transaction documents and completion of the legal due diligence review. Financial advice is normally provided by certified public accountants, since investment bankers do not often participate in Puerto Rico M&A transactions, unless it is a complex or cross-border transaction.

Given that the number of M&A transactions that take place in Puerto Rico is a fraction of the number of transactions that occur in Delaware and in other parts of the USA, the quantity of conflict of interest suits due to an M&A transaction is very limited. Nonetheless, there have been judicial claims involving directors’, officers’ and majority shareholders’ conflicts of interest. Plaintiffs bear the burden of proof to show that the decision was taken by the directors who had a personal interest in the transaction. Once they prove so, the business judgement rule presumption is rebutted and the burden of proof is shifted to the directors, who must prove that the transaction was entirely fair from a process and valuation perspective.

Although the General Corporations Act does not prohibit hostile tender offers, they are virtually non-existent given the private nature of businesses in Puerto Rico and the fact that transactions are always voluntarily negotiated transactions.

As discussed in 8.1 Principal Directors’ Duties, the directors owe a duty of care and a duty of loyalty to the corporation and to its shareholders and they must always act for the benefit of the corporation, be it in negotiating the price for the acquisition of a target company, the sale of the corporation or implementing a defensive measure to prevent an acquisition.

In Puerto Rico, the most common defensive measures are:

• super-majority (ie, two-thirds of votes) voting requirements;
• restrictions on transfer, including right of first refusal provisions that entitle other shareholders and/or the corporation to acquire the shares of a selling shareholder before that shareholder has the opportunity to sell them to a third party; and
• the creation of a staggered board of directors.

Additionally, directors could use “poison pills” as a defensive measure. However, this type of defensive measure remains rare in Puerto Rico.

The prevalence of these defensive measures has not changed due to the COVID-19 pandemic or its aftermath.

Directors owe a duty of care and a duty of loyalty to the corporation and to its shareholders. As previously mentioned, currently there is no local case law interpreting the applicability of the intermediate judicial scrutiny applicable to defensive measures executed by directors, as adopted by Delaware courts.

Under the General Corporations Act, the merger or acquisition agreement may provide that, at any moment before the certificate filed in the Puerto Rico Department of State becomes effective or before the closing of an asset purchase, the board of directors of any of the corporations involved in the transaction may terminate the agreement. This is so even if it has been approved by the shareholders of all or some of the corporations involved in the transaction.

Given the private nature of companies in Puerto Rico, local M&A transactions are friendly in nature. Hostile takeovers or acquisitions are only possible in the context of publicly traded companies and, as already explained, Puerto Rico only has a handful of publicly traded companies. As a result, litigation in the context of M&A transactions in Puerto Rico is very limited, particularly with regard to disputes between the purchaser and the target company. This contrasts significantly with the pattern witnessed in mainland USA, where M&A litigation is much more common.

Notwithstanding, given the complexity of Puerto Rico labour laws applicable to the sale of an ongoing concern, it is more common for litigation to arise in connection with severance payments, holiday pay and sick leave owed to retained and/or laid-off employees. To avoid potential litigation between the parties to a merger or acquisition transaction, each party’s responsibilities in connection with labour matters are generally subject to extensive negotiation and are carefully addressed in the agreements.

In the event that litigation does arise, it generally occurs following the execution and closing of the merger or acquisition agreement.

It is important to note that litigation may also arise in stages prior to a contractual relationship since under Puerto Rico law the parties have a duty to act in good faith in the preliminary negotiations of a contract. This is known as the “culpa in contrahendo” doctrine, which is now codified in the Civil Code of Puerto Rico of 2020, as amended. It would be necessary to prove to the court the pre-contractual responsibility of the other party and the fault and bad faith of the party in such pre-contractual stage.

Related to one important justification to terminate a purchase agreement, a matter that has continued to gain importance and has made even the most seasoned practitioners pause and ponder is the scope, carve-outs and other terms of a material adverse change (MAC) definition.

For the most part, Puerto Rico companies are closely held, wherein the shareholders are actively engaged in the day-to-day management of the business. As a result, shareholder activism in the traditional sense is not commonplace, particularly as an investment strategy. Thus, shareholder activism is mostly non-existent in Puerto Rico.

Activists are not common in Puerto Rico M&A transactions, due to the private nature of most business organisations. This has not changed as a result of the COVID-19 pandemic or its aftermath.

Since most local businesses in Puerto Rico are private in nature, activist investor presence is rare. Notwithstanding this, minority shareholders who are not actively involved in the management of the corporation may attempt to interfere with a proposed M&A transaction based on alleged breaches of fiduciary duties and claims of dissenting rights, although such interference is also extremely rare.