Five Key Legal Issues Affecting Private
Equity Transactions in Brazil
Breakfast Seminar organized by the
Brazilian-American Chamber of Commerce
New York City, November 13, 2008
1
Five Key Legal Issues
•
We will cover:
•
Who will hold the assets?
•
What will the shareholders agreement contain?
•
Should you set up a local fund or an international fund?
•
How can you take a listed company private?
•
Who will settle investment disputes?
2
Choosing an Investment Structure
•
•
In choosing an investment structure, investors must determine:
•
Who ultimately owns the investment?
•
Where do other investors hold interests?
•
What entity will operate the business?
The right investment structure will
• Facilitate governance arrangements
• Add predictability and flexibility to a planned exit
• Minimize taxes on distributions and upon a liquidity event
• Enable tax savings at the time of the original investment
• Minimize exposure to operating company liabilities
•
Trade-offs often involve non-comparable benefits:
• Lower taxes or control over exits or ease of oversight?
3
Choosing an Investment Structure(cont.)
•
Multiple-tier structures call for complex shareholder arrangements
to deal with exits and control
•
What entity will operate the business?
•
The operating company
• will actually control the business
• (so you want to exercise control at this level without
usurping the powers of management)
• will inevitably pay taxes on revenues and income
• (so you want to take advantage of (mostly) non-taxable
status of dividends and distributions generated by the
business)
• will eventually be the object of a liquidity event
• (so you prefer to invest as close as possible to the
actually sellable shares)
4
Choosing an Investment Structure (cont.)
•
How to fail at structuring an investment:
•
Minority investor has tag-along rights at operating company but
other shareholders exit at holding company level and purchaser
refuses to acquire stake held by minority investor
•
Shareholders cannot agree on terms of sale at the holding
company level, forcing control group to cause holding company
to sell 100% of target company – holding company is taxed on
capital gains at marginal rate of 34%
•
Minority investor relies on put option against company as exit
strategy. Company disputes enforceability of put option
against itself.
•
Minority investor obtains control rights (vetoes and board
representation) at holding company but fails to extend rights to
operating company. Operating company engages in related
party transactions with controlling shareholder.
5
Choosing an Investment Structure (cont.)
•
•
How to fail at structuring an investment (cont.):
•
Offshore entity acquires control of a Brazilian company at a
premium to book value. Premium cannot be moved into target
via merger to produce deductible amortization expenses
•
Minority investor relies on registration rights to exit company.
Market is closed and company resists a public offering
•
Investor balks at executing required representations in the
context of a public offering, by which investor vouches for the
accuracy of company disclosure. Public offering is jeopardized
for all other selling shareholders
Investment structures require planning
•
Some mistakes can be cured after the investment is made
•
Some mistakes cannot be cured
6
Entering into a Shareholders’ Agreement
•
Unless you acquire control, most of the value of an investment
resides in the shareholders’ agreement
•
Shareholders’ agreements are highly enforceable with respect to
control and exit arrangements
•
Shareholder agreement of a limitada is slightly less useful
•
Key issues in control arrangements:
•
Board representation and veto rights are key
• Look for requirement to vote as a block if parties jointly
control other (especially listed) companies
•
Who appoints the chair of the board? Who is the chair at
shareholder meeting?
• Self-help provisions rely on these individuals
•
What are the dispute resolution provisions?
• Arbitration is advisable but prepare for injunction battles
7 7
Entering into a Shareholders’ Agreement (cont.)
•
•
Key issues in exit arrangements:
•
Tag-along and first refusal rights generally work well
•
Call and put option rights also work well but are more litigationprone and should be exercisable against other shareholders
(and not the company)
•
Registration rights require special attention and have a shorter
track record
•
Redemption rights also require special attention, special
reserves and special treatment in the by-laws (not for
beginners)
All of these provisions may fit in a shareholders’ agreement (even if
some caveats apply)
8 8
Local Funds versus International Funds
•
•
International investors often had advantages:
•
Resolution 2689 investments retained status in public offerings,
despite legal niceties
•
Offshore sales to non-residents were not taxable, allowing for
tax-free exit to offshore buyers
Pendulum has swung to benefit local funds:
•
A FIP (fundo de investimento em participações) may qualify to
invest in a totally tax-free fashion:
• No taxes on capital gains realized by FIP
• No taxes on distributions made by FIP
• No taxes on capital gains realized by investors in FIP
•
Industry is shifting in response
9 9
Local Funds versus International Funds (cont.)
•
•
What is the state of the art?
•
International fund managers setting up shop in Brazil and
offering FIPs to international investors
•
Direct competition with local fund managers
•
International institutional investors becoming comfortable with
the FIP
•
Fund managers trying to accommodate the conflicting needs of
international and domestic institutional investors
How will the industry look like in five years?
•
Many megafirms will be in Brazil and offer FIPs
•
Many local firms will have (or continue to have) offshore funds
•
Many international investors will be comfortable investing in
FIPs
•
Domestic institutional investors will begin investing abroad
10 10
Going Private Transaction
•
The ultimate goal is to take a listed company private in a leveraged
buy-out
•
But CVM regulations make it difficult:
•
•
A listed company may not succeed to the debt incurred to
finance the acquisition of its control
•
A listed company may only cancel its listing if a tender offer is
made at a price that may ultimately be set by minority
shareholders
A company listed in the Bovespa special listing segments (Novo
Mercado and Level 2) must also comply with its listing agreement,
which requires the offer price to be set by an appraiser chosen by
non-controlling shareholders
•
Board will provide list of three appraisers
11 11
Going Private Transaction (cont.)
•
Reality check: When will a going private transaction work?
•
•
Can the company realistically use its cash to make a delisting
tender offer?
•
Is the controlling shareholder the only beneficiary?
•
How will management face public shareholders after an
unsuccessful , potentially bitter, delisting offer?
•
Is the legal authority granted to companies moot as a
practical matter?
Can anyone (including the controlling shareholder) be certain of
taking a company private?
•
How predictable are the negotiations with the minority
shareholders? (Remember, they will set the final, take-it-orleave-it price.)
•
How can lenders get comfortable with credit risk?
12 12
Going Private Transaction (cont.)
•
Key Legal Constraints
•
Offer price determined by an independent appraisal
•
Price must be supported by an appraisal report.
•
Novo Mercado: Appraiser is chosen by non-controlling
shareholders from a list of three experts selected by the board
of directors.
•
Minority shareholders (at least 10% of the public float) may
challenge the appraisal and seek the appointment of a new
appraiser
• New appraisal value controls but offeror may cancel offer
13 13
Going Private Transaction (cont.)
•
Oferor must undertake to pay additional amounts to selling
shareholders in the event of:
•
a change in control; or
•
any other corporate transaction authorizing the optional
redemption of shares of minority shareholders within one
year of the tender offer settlement.
•
Within ten days of the CVM decision granting registration for the
delisting tender offer, the offeror must publish an announcement
setting out the final terms of the tender offer and scheduling the
tender offer settlement date between the 30th and the 45th day
following the announcement.
•
Minimum Acceptance Requirements and Squeeze-Out
•
2/3 in interest of non-controlling shareholders must accept the
tender offer or consent to the delisting.
•
If less than 5% of a class of shares remains in the hands of
minority shareholders, the company may redeem these shares
at the offer price
14 14
Going Private Transaction (cont.)
•
•
Only shares held by non-controlling shareholders that have
designated a broker to represent them on the settlement date
will be taken into account in calculating the 2/3 threshold,
which may significantly lower the actual number of shares
needed to be acquired or to consent to the delisting.
•
If the remaining non-controlling shareholders after the
delisting tender offer hold less than 5% of the outstanding
shares, then the company may redeem the shares held by noncontrolling shareholders at the offer price.
Settlement Date
•
•
On the Settlement Date, non-controlling shareholders must
tender their shares or express their consent or objection to the
delisting and deregistration through a broker authorized to
trade on the stock exchange.
Bidding Up the Offer Price.
•
The offeror may increase the share price on the Settlement
Date.
•
Other parties may enter competing bids.
15 15
Going Private Transaction (cont.)
•
Offeror must accept tender of shares for 3 months following
Settlement Date
•
•
Non-controlling shareholders may tender their shares at any
time during the three months following the Settlement Date of a
successful delisting tender offer. The offeror will be required to
pay the offer price, adjusted for inflation, within 15 days of the
tender by any shareholder. Tax treatment will be different
Issuance price of shares may be additional floor on the offer price
•
The issuance price of shares issued during the one-year period
preceding the tender offer in any unregistered offering will set
an additional floor for the tender offer price if (i) more than onethird of the shares available for purchase by minority
shareholders were in fact acquired by minority shareholders,
and (ii) 10% or more of the issued shares remain in the hands
of public investors.
16 16
Going Private Transaction (cont.)
•
CVM will delist within 15 days of successful tender offer settlement
•
•
Company will be barred from listing for two years
•
•
The CVM will delist and deregister a company within 15 days of
the Settlement Date if the relevant conditions have been shown
to be satisfied.
A company that delists from any special listing segment of
Bovespa will not be permitted to apply for a listing again on the
respective segment for a period of two years from the date of
delisting.
Company must also repurchase other outstanding securities
•
A company that has issued other kinds of publicly-traded
securities besides shares in the Brazilian capital markets must
also demonstrate that it has repurchased or redeemed all
outstanding securities before applying to delist and deregister.
17 17
Dispute Resolution
•
Arbitration trumps any other method to resolve investment disputes
(i.e., disputes under a shareholders’ agreement)
•
Brazilian arbitration practice has become increasingly
responsive to business needs
•
Contrast with court proceedings is dramatic:
•
In arbitration, any law can be chosen to apply and any
language can be used
•
•
In arbitration, parties may select seat outside Brazil
•
•
In court, parties may only select a forum within Brazil
In arbitration, a decision on the merits takes 1-2 years
•
•
In court, only Brazilian law will govern a shareholders
agreement and only Portuguese will be used
In court, a decision on the merits may take 5 to 10
years
In arbitration, parties choose qualifications of arbitrators
•
In court, the judge may have limited business
experience
18 18
Dispute Resolution (cont.)
•
•
The limitations of arbitration are few but real:
•
An injunction to stay a business decision or a transaction will
likely require a court decision, which may be reconsidered by
the arbitral tribunal
•
Ultimate enforcement requires court assistance, although
•
Brazil has now acceded to the New York Convention
•
Parties tend to settle’
•
Costs are not insignificant
•
No dispute resolution mechanism avoids the cost of
opportunity
Tough issues in arbitration include:
•
Multi-party arbitration among various investors
•
Non-signatories
•
Damages
19 19
Further inquiries
If you have any questions regarding this presentation, please
contact:
In New York City
Daniel Calhman de Miranda
135 East 57th Street 12th Floor
New York, NY, USA 10022
Tel.: 1-646-695-1100
Fax: 1-646-695-1110
20 20