The Acquisition Finance market in Brasil for Lawyer Reference
The forecast is that there will be an increment in the M&A deal activity in 2018 and the fall in interest rates could be a positive influence over acquisition financings in 2018.
Acquisition Finance
1. What was the level of debt-financed M&A in your jurisdiction in 2017? Was there any industry or sector that saw any noteworthy uptick in M&A and related financing deal activity in 2017 in your jurisdiction?
There is no specific information about the subject compiled or published by official or reliable organisations. However, there is information available indicating that there was an increase in the number of M&A operations in comparison with 2016, indicating a rise in confidence by investors. The technology sector had the highest number of transactions in 2017, repeating the 2016 performance. With respect to the volume of investments (based on some information available, since a significant part of the M&A transaction values are not revealed in Brazil), the sectors of internet and TI, food, beverage, tobacco, health, energy, real estate, education, oil and gas and pulp and paper should be highlighted.
2. What types of investors are the most frequent sources of acquisition financing in your jurisdiction?
The data published on the subject in recent years has indicated a predominance of Brazilian investors, especially from the Southeast region of Brazil. In 2017, even in the face of the gradual recovery of the domestic economic scenario, foreign investments were similar to those for the previous year. Although the involvement of financial investors in the Brazilian market has increased in recent years, there is still a preponderance of strategic investors in relation to financial investors.
3. What types of debt instruments do you most frequently see for local acquisition financings, and in what currency are these instruments most frequently denominated?
Over the past few years, there has been an increase in debt-financed mergers and acquisitions. Bonds, such as debentures are the most widely used instruments by major companies. Nevertheless, we also see most commonly bilateral credit facilities and, to a lesser extent, syndicated loans. We should also highlight the role of the Brazilian Development Bank – BNDES – a public development bank that acts as an important instrument of the federal government – as source of financing for long-term financing and which funds many M&A transactions in Brazil, including direct investment, by means of BNDES Participações SA – BNDESPAR, its equity branch, although the replacement of TJLP (long-term interest rate), which was BNDES former base rate, with TLP (long-term rate) for contracts signed after 1 January 2018 can encourage private financing in the future. Acquisitions between local parties are generally made in Brazilian currency (BRL), especially considering that there is a legal restriction on agreement for payments in foreign currency (subject to some legal exceptions). When the financing party is a foreign entity, the transactions are usually denominated in US dollars.
4. What are the usual maturities and amortisation profiles of acquisition-financing credit facilities?
The maturities and amortisation profiles are usually greater than one year, especially in the case of funding by public banks. Due to the dynamics of the Brazilian market, debentures and bonds in general are commonly issued with maturities not exceeding three or four years. If credit is raised abroad, due to more favourable rates and conditions, the terms may be longer.
5. Discuss the types of conditions to funding you have seen in recent acquisition financings in your jurisdiction.
As Brazil’s credit market is not so developed as in other countries and considering the risks generally involved in financing transactions, it is common that the level of conditionality in Brazilian transactions is significant. As an example, one can mention that the constitution of securities, the results of the due diligence and a firm commitment to close the M&A transaction are common conditions in Brazilian acquisition financings, regardless if the lenders are local or foreign.
6. Are there legal, banking, currency exchange, regulatory or other considerations that favour certain sources of funds over others? For instance, mandatory reserve or deposit requirements? Do the requirements vary by type and location of investor or lender? Were there any changes in the regulatory environment last year or are there any proposed changes for the current year that are likely to affect M&A and related financing deal activity?
With respect to the subject, an example is that the Tax on Financial Transactions (IOF) is not levied on the credit arising out of debentures, which encourages its use. Regarding other important tax aspects, please see question 6. In general, the law does not differentiate Brazilian investors from foreign investors, except with respect to specific issues such as, for example, transactions involving the acquisition of rural real estate, in which there are restrictions. It is also noteworthy that the procedures related to foreign capital registration have been quite simplified over the last decade, promoting the investment environment in the country.
7. What is the withholding tax treatment of acquisition finance loans made by, and bonds purchased by, foreign investors in your jurisdiction? Were there any changes in tax laws in 2017 that are likely to affect M&A and related financing deal activity?
Payments of interest to non-residents are generally subject to a 15 per cent withholding income tax (WHT). Such rate may be reduced due to a provision of a Double Tax Treaty entered into between Brazil and the country in which the foreign investor is located in and increased to 25 per cent in case of remittances to tax havens.
Investments made in Brazil by non-residents (such as bonds) are generally subject to taxation in Brazil according to the rules applicable to individuals residing in Brazil. However, WHT rate reductions (in some cases, to zero per cent) and exemptions apply to certain payments made to non-residents related to investments that comply with the conditions set out in Brazilian legislation (eg, bonds with fixed rates, minimum average term of four years, among other conditions; investment funds composed solely by foreign investors), including non-traditional debt investments such as foreign sovereign wealth funds.
In the second half of 2017, the Brazilian tax authorities confirmed their understanding that the capital gains accrued by non-resident legal entities arising from the sale of non-current assets and rights in Brazil, including equity stake in Brazilian companies, are subject to WHT at the same progressive rates applicable to individuals residing in Brazil as of 1 January 2017: 15 per cent (gains of up to 5 million reais) to 22.5 per cent (gains higher than 30 million reais). WHT was previously levied at a 15 per cent rate on such gains. M&A transactions in 2017 were affected by this change and may continue to do so in the following year. Other factors that could also affect M&A and related financing deal activity are the tax authorities’ special attention in 2018 to transactions involving payment of goodwill, as well as the increasing compliance obligations required from Brazilian taxpayers.
8. Are there limitations on the ability of the parties to choose a foreign law as the governing law of the financing or to select a foreign forum for dispute resolution? Discuss any limitations with respect to enforceability of the financing documents as a result of choosing a foreign law.
There is no express legal prohibition from choosing a foreign governing law. However, Decree-Law 4657/42 (Law of Introduction to the Brazilian Law Rules) establishes some rules on the subject, among which we mention, for example: (i) obligations shall be qualified and governed by the law of the country in which they were established (article 9); (ii) if the obligation is to be performed in Brazil and is subject to a required form, such obligation shall be observed, accepting the specificities of the foreign law as to the extrinsic requirements of the act (article 9, paragraph 1); (iii) the obligation resulting from the contract is established on the proponent’s place of residence. The same law also brings some rules regarding the jurisdiction, among which we also selected the following examples: (x) the Brazilian judicial authority is competent when defendant is domiciled in Brazil or the obligation must be complied with here (article 12); (y) only the Brazilian judicial authority is entitled to hear actions related to real estate located in Brazil (article 12, paragraph 1). In contracts with Brazilian parties, related to goods located in Brazil or providing for obligations that can be met in Brazil, the convenience of choosing the applicable law – whether foreign or of foreign jurisdiction – to resolve disputes should be evaluated on a case by case basis, considering if there is an option for arbitration or if the disputes will be solved judicially. In fact, for the purposes of Law 9307/96 (Arbitration Law), the parties are free to choose the applicable law and the place of arbitration. In other words, the parties have more freedom to choose when they submit disputes to arbitration. Additionally, it is worth mentioning that foreign judgments and arbitration awards must be submitted to validation (homologação) by the Superior Court of Justice before they are enforced in Brazil.
9. Does the local insolvency regime treat lenders under an unsecured credit facility on a on a pari passu basis with all other unsecured obligations of the debtor?
The insolvency law in Brazil treats lenders under an unsecured credit facility as general creditors on a pari passu basis with other unsecured creditors (without any privilege).
10. Discuss the legal and practical limitations on obtaining a valid and perfected security interest. Are there any documentation, execution or delivery formalities required by local law to make the security interest enforceable against the debtor and third parties? Is it possible to create a floating blanket lien on all of the debtor’s assets?
Generally, the posting of bonds is made by means of written documents (eg, mortgage, pledge, chattel mortgage, surety); in some cases, a public deed or a legally equivalent document is required (eg, mortgage). The constitution of guarantees, such as mortgages and pledges, depends on the registration of the corresponding instrument, and the law establishes where such registration must occur (for example, the registration of common pledges must be made at the Registry of Deeds and Documents, and the registration of mortgage must be attached to the real estate registration of the mortgaged property, at the competent Real Estate Registry Office). The registration is essential for this type of guarantee to take effect vis-à-vis third parties. There is no guarantee that encumbers, in general terms, all the debtor’s assets; to encumber each one of the assets it is necessary to provide a guarantee on each of them. Nevertheless, a personal guarantor will be liable for the debt with all his or her assets, except if otherwise agreed. The joint and several liability between debtor and guarantor or guarantors is usually not presumed and must be established in writing.
11. Does the local insolvency regime enable complex capital structures, for instance, recognising the validity of subordination of payment, subordination of liens, and other inter-creditor agreements?
The classification of the credits in the order of payment set forth by the insolvency law depends on the nature of the credit. Therefore, it is not possible to change the classification of credits, by means on agreement among creditors or any other agreement. Additionally, the assignment of credit or any other transaction involving the credit does not affect the material and procedural rights related to such credit and the assignee subrogates in all rights of the original creditor.
12. If an equity investor provides some of the debt financing, do local insolvency rules afford those loans equal treatment as other (third-party) loans?
There is no special treatment for debt financing provided by equity investors, the only preference set forth in the insolvency law in Brazil is to credits granted during a judicial process of recovery, in case the company was not able to recover and its bankruptcy was declared.
13. Are there any other insolvency considerations that a foreign debt-investor or lender should be aware of?
The foreign debt-investor should also be aware that the declaration of the bankruptcy causes the immediate maturity of all debts of the company, and that the debts in foreign currency shall be converted into national currency based on the exchange rate of the date of the bankruptcy declaration is made.
14. What do you expect to see in terms of market developments for acquisition financings in 2018?
The forecast is that there will be an increment in the M&A deal activity in 2018 and the fall in interest rates could be a positive influence over acquisition financings in 2018. The rebound in the economy can also increase the number of transactions in the retail market, although the technology sector is expected to continue as the most promising niche. The impacts of Operation Car Wash and its branches are expected to continue affecting the infrastructure market, implying the intensification of the divestment strategies and the preservation or increase of the judicial recovery proceedings volume. On the other hand, although the current government have succeeded in approving major measures, as the labour reform, the forthcoming presidential elections can change the political scenario and retract investments in the second semester.
This article was first published by Latin Lawyer in June 2018 on https://latinlawyer.com/know-how/topics/1000334/acquisition-finance