The Saga of U.S. Investors Doing Cross-Border Asset Deals in Brazil
By Alan Parker*
After a very divisive and disputed presidential election, for the first time in its recent democratic history, Brazil elected a conservative pro-market president who is keen to push the necessary economic reforms. The positive economic outlook will probably drive the growth of mergers & acquisitions (M&A) in Brazil in 2019, a trend that was already happening in 2018 despite the everlasting political and economic uncertainty of the previous years.
American companies and investors also continue to play a significant role in the Brazilian markets, maintaining the number one spot in terms of deal volume. China, on the other hand, continues to be the number one player in terms of deal values.
In the U.S., many domestic M&A transactions are performed through asset deals, where a group of corporate assets such as real estate, machinery, software, intellectual property, receivables etc. are sold without the sale of stock (or equity) of the company holding such assets.
There are a number of factors driving American companies and investors to adopt this asset sale structure. Some examples include the possibility of “cherry picking” specific assets and liabilities and having a step up in basis of the acquired assets. The U.S. tax reform, approved in December 2017 by the Trump administration, can also contribute to the increase of transactions structured through asset deals, as buyers may now enjoy significant discounts on cash-purchase prices given the new depreciation rules.
Very often, deals that are originated in the U.S. also involve subsidiaries in other countries, including Brazil. What generally occurs in these cases is that the American parties and its legal and financial advisors decide on a general deal structure, and subsequently try to replicate such main deal structure to the local acquisitions or sales to be performed in each country where there is a subsidiary, subject to the local laws and requirements.
As a result, many global and U.S. transactions are being replicated as asset deals in Brazil, but foreign investors in Brazil should be aware that this may result in significant delays in the deal flow and completion.
Having that said, subject to specific circumstances in which asset deals would present advantages, in Brazil it is a more common practice for a target to be acquired through a stock transaction, where equity is transferred and the buyer becomes the owner of the company that holds the assets and conducts the business. In addition to being simpler to implement, from a tax perspective, the stock deal can also present advantages if the target has accrued losses, which may occasionally be offset against future taxable income. Also, payment of goodwill may be subject to amortization and generate tax- deductible expenses in the target.
As opposed to the above, asset deals can be extremely inefficient and burdensome to implement in Brazil. If the sale comprises a significant part or 100% of the assets in Brazil, the sale will probably be subject to the specific regulations of “commercial establishment” under Brazilian law. Several obligations arise under these regulations, which would include, as an example, requirements that sellers have sufficient assets left behind, under penalty of having to obtain creditor consent, as well as strict rules regarding liability for unpaid debts, among many others.
Regardless of the commercial establishment regulations, an asset deal in Brazil would require not only the “master asset purchase agreement” that governs the main terms and conditions of the transaction, but many separate agreements and deeds for transfer of the real estate, intellectual property, cars, and other assets. Moreover, if the seller of the assets leaves an empty shelf company behind, it will probably be extremely difficult and burdensome to liquidate such company after the asset sale.
After the execution of the separate agreements for the specific assets, deal teams in Brazil will enter into one of the most complicated stages of an asset deal, which is the filing for new operational licenses or transferring the previous ones to the new owner of the assets. Evidently, this varies on a case-by-case basis, but when there are certain environmental or regulatory licenses involved, a transfer can take more than a year, which could significantly undermine the efforts for the consummation of the global transaction.
The difficulties mentioned above are in direct contrast to the goals of the deal teams, which is to have the assets and respective operating licenses transferred to the buyer without interruptions of the business activities.
An excellent alternative to a pure asset deal in Brazil is the performance of a local reorganization (e.g. drop-down or partial spin-off of the Brazilian assets to a seller newly formed company (newco)) and subsequently sell the stock of the capitalized NewCo (holder of the assets) to the buyer.
From a timing perspective, this type of reorganization structure, which has a variety of different alternatives under Brazilian law, can be much more efficient, both for sellers and buyers, because the general rule is that assets, liabilities and underlying licenses are automatically transferred to different entities by the succession rule applied to mergers, spin-offs, and sales of stock in Brazil. However, even with the straightforward succession rule, the lack of communication between different government bodies and general bureaucratic process applied to these transactions can still cause delays in the transfer of licenses from sellers to buyers.
Another advantage of the reorganization and stock sale approach is that seller will pass along the corporate entity holding the assets, as opposed to keeping an empty shelf company behind, which can still be subject to third party claims and, as mentioned above, extremely difficult and burdensome to liquidate. In addition, mergers and spin- offs are deemed transfers of capital stock, so in theory, they are neutral from an income tax perspective in Brazil.
If 100% of the assets of a Brazilian subsidiary are to be sold: buyer incorporates a local company (newco) and either (a) performs a merger of seller subsidiary into newco, or (b) a straightforward acquisition of shares of newco by buyer; or
If less than 100% of the assets of a Brazilian subsidiary are to be sold: seller subsidiary performs drop-down of specific assets or a partial spin-off of such assets to a newly formed company (newco) with the subsequent sale of shares of newco to the buyer. The drop-down or partial spin-off can also be made directly from seller subsidiary to the buyer, without the need of a NewCo.
In both cases mentioned above, the surviving entity and the buyer succeeds in all rights and obligations related to the assets, whereby the business activities can carry on forward without major disruptions or interruptions, as opposed to what would probably occur in a straight asset sale. The bottom line is, the sooner Brazilian and U.S. advisors talk, the better, as this can avoid unexpected surprises in the global and local deal flows.
* Alan Parker is a Senior Associate at the Rio de Janeiro offices of Veirano Advogados.