I OVERVIEW OF M&A ACTIVITY
Panama’s economy continues to lead those of Latin America with a GDP growth of 5.8 per cent in 2015, and an approximate growth of 6 per cent in 2016. The economy will be supported by the commencement of the operation of the expanded Canal and lower fuel prices, which is expected to counterbalance the current scenario of slow economic growth worldwide and the US dollar appreciation. In the medium term, industries such as logistics, energy and mining are expected to help maintain vibrant economic growth. In June 2014, the Financial Action Task Force (FATF) included Panama in the list of countries with deficiencies in the areas of anti-money laundering and the combating of the financing of terrorism. To this end, the authorities have implemented an action plan approved by the FATF. In February 2016, the FATF recognised this progress by removing Panama from the list. Despite the recent reputational damage to the country’s offshore services industry due to the ‘Panama Papers’, Fitch Ratings affirmed Panama’s rating as BBB (stable) in April 2016 and forecast a real GDP growth of 6.1 per cent in 2016.2 M&A activity in Panama is expected to remain stable with a slight increase in cross-border transaction costs due to greater scrutiny on compliance, and anti-money laundering and tax regulations.
Large projects such as the estimated US$500 million expansion of the International Tocumen Airport, the US$1.6 billion construction of the first line of metropolitan transportation system and the US$5.25 billion expansion of the Panama Canal have all been motivating factors in increased foreign investment in Panama. The recent inauguration of the Panama Canal expansion project is expected to increase M&A activity in the future. Currently the Panama Canal, the backbone of the Panamanian economy, contributes approximately US$1.1 billion to the national revenue; in the long term, this revenue is expected to increase up to US$4 billion per year after the start of operations of the expansion of the project. The logistics and maritime services industries are expected to grow soon after the start of the operations of the Panama Canal expansion. The expansion of the Panama Canal will open up opportunities for outright acquisitions and joint-venture investments in diverse industries such as transportation, export processing and maritime-complementary services. To contribute the growth of these industries, President Juan Carlos Varela has pledged US$3.2 billion for the development of various civil works for infrastructure redevelopment. A further US$2 billion third metro line, consisting of a light or monorail system stretching for 25km to the west of Panama and crossing the Panama Canal, is expected to be ready for bid in 2017.3 Complementing these public infrastructure projects is a planned civil works project for the construction of a fourth bridge over the Panama Canal.
The energy sector in Panama will continue to experience significant government as well as foreign direct investment. Given Panama’s long-running economic growth, it is not surprising that energy demand in the country is expected to continue to increase at an annual rate of between 4.8 and approximately 7.4 per cent. Under this scenario, the government has announced public works regarding new transmission lines. Transmission Line 3, which is expected to be completed by September 2016, and Transmission Line 4, which will have an approximate cost of US$450 million, will help cope with the country’s energy demand. At the same time, the increased demand further creates opportunities for foreign direct investment, which is expected to come from the private sector.
The IMF Western Hemisphere Department recognised the positive future of Panama’s growth due to the expansion of the Panama Canal, development of several services industries, the approval of free trade agreements with the United States, the European Union and Canada, as well as the growth of the mining industry.4 The mining of copper has significantly contributed to the growth of the mining industry, which has only recently started to be tapped. The Cobre Panama copper mine was recently acquired and is now controlled by First Quantum Minerals. It should be up and running by 2017, and is estimated to produce 300,000 tonnes of copper per year.5 As noted in a recent International Monetary Fund (IMF) Country Report for 2014, the copper mine is expected to bring about ‘US$6½ billion over 2013–17, of which about US$1½ billion has already invested’.6
Panama is consistently rated by international indexes as one of the best countries in Latin America for business and investment. The World Bank’s 2016 Doing Business Index recently ranked Panama No. 69 out of 189 surveyed countries.7 This may be due to its encouragement of foreign investment through legal incentives. In 1998, the government enacted the Investment Stability Law, which guarantees foreign investors who invest at least US$2 million in Panama equal treatment under the Law as that given to their domestic competition. Under Law 41 (2007), Panama has motivated multinational companies to locate their headquarters in Panama through the offering of tax incentives under Law 41 (2007). As of 11 March 2015, 110 international companies have been established under this Law, such as major multinational companies such as Hyundai, Procter & Gamble, AES, Halliburton Hewlett-Packard, Peugeot/Citroën, Pan-American Life Insurance Company, Caterpillar, LG, 3M, Western Union and Roche due to several incentives offered in terms of taxation, immigration, labour and employment enacted specifically to benefit multinationals that establish their regional offices or headquarters in Panama.8
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
The relevant Panamanian laws and regulations governing business combinations include the Corporations Law, the Limited Liability Company Law and the Commercial Code, which is supplemented by the Civil Code. As combinations generally cause taxable events, the Tax Code and its regulations (especially Executive Decree 18 of 1994, which establishes a special regime regarding share-for-share mergers) and Law No. 18 of 2006, which created a special capital gains regime, are also pertinent. In the case of publicly traded companies, Decree Law No. 1 of 1998 and its regulations (the Securities Law) govern tender offers, proxy statements and rules of disclosure, among other matters.
Business combinations in Panama are usually structured as share or asset purchases, tender offers or mergers, but other techniques can also be used. One example is the capitalisation of shares of two operating companies to a holding company incorporated for that purpose with joint participation in the holding company. In the case of publicly traded companies, combinations usually involve a two-step process that begins with a tender offer (either for shares, cash or a combination of both) followed by an actual merger.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
Corporate and takeover law can be divided into two kinds of transactions: mergers and share and asset purchases. In the case of mergers, Panama law allows a company to be absorbed by another regardless of the place of incorporation of either firm (merger by absorption). It also allows two companies to merge forming a new consolidated body. Once a merger becomes effective, the absorbed company ceases to exist as a legal entity, and the surviving company assumes all the assets, rights, licences, capital, liabilities and obligations of the absorbed company by universal succession. Unless the articles of incorporation state otherwise, a merger agreement must be executed by a majority of the directors of each company, and approved by the holders of a majority of issued and outstanding shares of each firm. The merger agreement must then be registered with the Registry of Companies in Panama to bring it into effect, unless a later effective date is defined in the merger agreement.
Regarding share and asset purchases, unless the articles of incorporation state otherwise, the acquisition of a company generally requires approval from a majority of the directors of the acquiring company regardless of whether it is structured as a share or an asset purchase. On the other hand, the sale of a company, if it represents all or substantially all of the assets of the seller, generally requires approval from both a majority of the directors and from the holders of the majority of all the issued and outstanding shares with the right to voting rights of the selling company.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Foreign direct investment continues to be a principal driver of M&A activity, and in almost all of the more recent M&A transactions in Panama, foreign and multinational corporations have targeted local companies. Political instability in nearby Latin American countries has also been a substantial driver for inbound investments into Panama, as individuals and companies seek to diversify their country risk.
Generally, there are no foreign ownership restrictions in Panama. Due to issues of national security and national interest concerns, however, ownership of local companies by foreign governments or nationals is restricted in certain industries including, inter alia, aviation, radio and TV, and retail trade. In the case of the retail services market, foreign participation is generally prohibited with very few exceptions.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
Most important sectors of the Panamanian economy have been subject to cross-border acquisitions, but M&A activity is expected to continue to be distributed across several industries, led most likely by the traditional financial services (including insurance) and energy sectors, followed by food and retail industries (both wholesale and consumer sales). In the wake of the Panama Papers and the controversy surrounding money-laundering allegations involving a prominent retail trade group, tax, regulatory and anti-corruption compliance issues are likely to play a central role in any M&A due diligence process that involves a Panamanian entity.
The banking sector, which is Panama’s stronghold, has seen a recent trend towards consolidation and regionalisation, with the exit of established international players such as HSBC, Citi and BNP Paribas from the local market giving way to the presence of more regional banking groups, led primarily by Colombian multinational conglomerates. On 1 February 2016 Scotiabank acquired 100 per cent of the shares of Citibank Panamá. Prior to that, in 2013, Grupo Aval of Colombia finalised the acquisition (through a merger with affiliate BAC International Bank Inc) of the local subsidiary of Banco Bilbao Vizcaya Argentaria for an estimated purchase price of US$646 million. Consolidation among small and medium-sized banks is expected to pick up, spurred by reduced access to correspondent banks who are limiting their services due to local regulatory burdens and increased compliance standards imposed on foreign banks and the perceived reputational risk stemming from the publication of the Panama Papers. This is a current issue in the Panamanian financial services sector that may have further long-term implications.
Given the previously mentioned demand for energy in Panama and the region, the energy sector has been the object of recent important acquisitions and new market entrants, including CELSIA’s (part of the Colombian conglomerate Grupo Argos) acquisition of GDF Suez assets in Panama and Costa Rica, for a reported US$830 million, and InterEnergy Holding’s simultaneous acquisition and US$300 million project financing of the construction of Phase II and Phase III of the Penonome wind power plant, the largest wind farm in Central America. Once operational, the 86 wind turbines, with an installed capacity of 215MW, are expected to generate 448GWh of energy per year, roughly equivalent to 5 per cent of the country’s total energy demand. Significant acquisitions and joint ventures are expected in the next few years in this sector, as Panama continues to find and incentivise new sources of energy for its rising demand, while further regulating its existing non-renewable and renewable resources.
Increased deal activity is expected following the now-complete expansion on the logistics, transportation and distribution and maritime industries, which represent approximately 20 to 25 per cent of the country’s GDP. To that end, the government acquired Transporte Masivo de Panamá, SA (Mi Bus), the concessionaire and operator of the mass transportation system in the metropolitan area of Panama City. Meanwhile, the Panama Canal Authority recently announced the short list of pre-qualified bidders for the new port terminal in Corozal, located near the Pacific entrance to the Panama Canal and capable of accommodating Post-Panamax ships with docking facilities with an estimated depth of 60 feet, and the capacity to handle 5 million TEUs in a 296-acre area.
In recent years, M&A deals in Panama have had many drivers. Certain deals have been instigated by the need to consolidate in a very competitive environment; others have been undertaken to control costs and exploit synergies, or have been fuelled by the global economy and the need to develop new international markets and expand market share. Some of the largest transactions in Central America have included a Panamanian target company, independent of whether it is an operating company or a holding company registered in Panama with operations in the region. Additionally, we are seeing a move from New York law or New York-run deals to Panama law or Panama-run deals for Latin America-based transactions that do not necessarily have a connection to Panama.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
M&A financing in Panama is usually provided by local and international banks, as there are no limitations in Panama on international lending. It is also worth noting that with the end of the financial crisis, deals have also been funded by private equity firms or through local and international securities issues.
VII EMPLOYMENT LAW
In a merger scenario, the surviving company assumes the labour relations and liabilities of the absorbed company. Similarly, in share acquisitions, the target company retains responsibility for labour relations and liabilities. Asset acquisitions, however, present a special case. If the sale comprises all or almost all of the assets, causing business operations to be transferred, both the buyer of the assets – the new employer – and the seller are, for a one-year period following the acquisition, jointly and severally responsible for all labour liabilities that arise prior to the acquisition of the assets or business. Furthermore, employees retain all their rights and benefits, and no adverse changes can be made to their terms of employment. Thus, in many asset acquisitions, insofar as may be legally feasible, buyers require sellers to terminate all or certain labour relations as a precondition to closing a deal, in order to rehire some employees on more favourable terms. Labour unions and employees must be notified of the employer substitution even though they cannot prevent it from taking place.
VIII TAX LAW
One of the main components of any sell-side deal structuring is taxation. The structure of an acquisition is usually influenced to a large extent by the need to make the transaction tax effective for the seller, without causing adverse tax consequences to the buyer. As Panama generally follows a territorial system of taxation, only Panama-source income (generally income and capital gains realised in connection with a trade, business or real estate transaction in Panama) is taxable. Thus, mergers or acquisitions of companies organised in Panama that do not carry out any trade or business or own assets within the country are generally not taxable. Mergers or acquisitions are generally structured as either share-for-share transactions or share-for-cash transactions, or a combination of both. Acquisitions can also be fashioned as a straight purchase of shares or a purchase of assets. A brief description of the tax treatment for each follows.
Share-for-share mergers are tax-free transactions, provided that no cash is paid out (except up to 1 per cent of the value of the transaction for adjustments of fractional shares) and certain other accounting parameters are followed. In a share-for-share merger, the shareholders of the merged company keep a tax basis on the shares of the surviving company that they receive equal to their average pre-merger tax basis of the surrendered shares.
Share-for-cash mergers, on the other hand, are not tax-free transactions. Gains realised by sellers in these transactions, which are deemed to be gains from Panama-sourced income, are subject to a 10 per cent capital gains tax. The capital gain is the difference between the selling price allocated to Panamanian sources and the tax basis of the shares owned by the selling shareholder. Furthermore, the law requires buyers to withhold 5 per cent of the total purchase price allocated to Panamanian sources (as an advance of the capital gains tax) and directly pay this amount to the tax authorities within 10 days of the transfer of the shares. It is important to note that a buyer, as well as the target company whose shares are being acquired, are jointly and severally liable with the buyer for the payment of the 5 per cent advance capital gains withholding. If the 10 per cent capital gains tax on the realised capital gain is less than the 5 per cent advance withholding, sellers can request a tax credit for the difference. This credit must be used in the same fiscal year as that in which the capital gain is realised. Alternatively, sellers can choose to treat the 5 per cent advance capital gains withholding as the final and definitive capital gains tax payable in connection with the sale of the shares. In practice, most sellers pay the 5 per cent purchase price capital gains withholding, as it is difficult to request and use the tax credit in the same year that the transaction took place.
Share purchases are subject to a 10 per cent capital gains tax on Panama-sourced gains in the same manner that share-for-cash mergers are taxed, including the 5 per cent advance withholding obligation. The Department of Revenue of the Ministry of Economy and Finance has repeatedly taken the position that capital gains tax applies to the sale of the shares not only of Panamanian corporations, but also of any upstream company, regardless of its jurisdiction of incorporation, as long as this company, directly or through one or more subsidiaries, has Panama-source income. Consequently, gains derived from the direct or indirect transfer of shares of a legal entity that has obtained Panama-sourced income is subject to tax at a rate of 10 per cent.
Due to a tax reform (Decree Law 135 of 2012), where a transaction involves, indirectly, the transfer of shares of a Panamanian company with Panama-sourced income, the seller and buyer can now apply pre-established calculations to determine the capital gains tax due on the percentage of the transaction’s purchase price that is attributable to the Panamanian assets. To pay the capital gains tax, the buyer and seller will need to file a joint sworn affidavit setting forth the total capital gains tax paid and the calculations used to arrive at the figure. In addition, the buyer, who is responsible for the payment, must obtain a temporary tax identification number in Panama, known as 8-NT, in report and pay the capital gains tax. This temporary registration has no additional tax implications or reporting requirements in Panama for the buyer.
Asset purchases are generally taxable events in Panama. Gains realised on the sale or disposition of assets located in Panama are generally subject to a 10 per cent capital gains tax. In addition, the transfer of chattel property, such as inventory or equipment, is subject to a value added tax equal to 7 per cent, and the transfer of real estate is subject to a 2 per cent transfer tax. In addition, buyers of an ongoing business concern must be aware that they will become liable for past taxes of the business, even if they are buying the assets of the business and not shares of the company.
Frequently, M&A transactions involve either a pre-closing dividend to exclude assets from the transaction or a post-closing dividend to distribute gains to shareholders. In this regard, as a general rule, corporations in Panama are subject to a 10 per cent dividend tax (20 per cent if the shares are issued to the bearer), on Panama-sourced income. Thus, income that is not Panama-sourced income is generally not subject to dividend tax in Panama. However, due to a recent tax reform, if the company paying the dividend engages in commercial or business activities in Panama that require the company to obtain a business licence, then in addition to paying the 10 per cent dividend tax on Panama-sourced income, it is also subject to a 5 per cent dividend tax on non-Panama sourced income.
Goodwill is another frequent point of conflict between buyers and sellers. Buyers generally want to be able to claim a tax deduction for the amortisation of any goodwill paid in the acquisition. However, amortisation of goodwill is only deductible in Panama if the seller recognises the goodwill as income on its annual tax return.
IX COMPETITION LAW
In Panama, there is no mandatory merger control approval process; the process is entirely voluntary. That said, with the new antitrust and competition regime established by the Competition Law, economic concentrations created by the mergers of conglomerates within the Panamanian market have come under increasing, albeit still limited, scrutiny by regulators. The Competition Law prohibits economic concentrations whose effects may unreasonably restrict or harm free competition. An ‘economic concentration’ is defined as the merger, acquisition of control, or any other act pursuant to which corporations, associations, shares, trusts, establishments or any other kind of assets are combined, and which occurs between suppliers or potential suppliers, customers or potential customers, and other competing or potentially competing economic agents. The law applies to any acts or practices that may unreasonably restrict or harm free competition, and whose effects take place in Panama, regardless of where those acts have been carried out or perfected.
The Competition Law does not prohibit all economic concentrations, but only those whose effects may unreasonably restrict or harm competition. In addition, the Competition Law expressly provides that the following business combinations shall not be deemed prohibited economic concentrations: joint ventures formed for a definite period of time to carry out a particular project, which is also contemplated in other jurisdictions; economic concentrations among competitors that do not have harmful effects on competition and the market; and economic concentrations involving an economic agent that is insolvent, if certain conditions are met, which is, roughly speaking, equivalent to the failing company exemption prevalent in other jurisdictions.
Moreover, economic concentrations with restrictive effects on competition may obtain clearance from the Competition Authority if the restrictive effects of the concentrations are outweighed by their contribution to obtaining further efficiencies, such as:
- a improvements in commercialisation and production systems;
- b fostering technical and economic progress;
- c improvements in the competitiveness of the industry; and
- d contributions to consumer interests.
If advance verification for the economic concentration is sought and approved, the economic concentration cannot be subsequently challenged. If no advanced verification is sought and the transaction has been consummated, the Competition Authority Authority may file a lawsuit with a specialised superior court within three years of the transaction’s effective date if it considers the economic concentration to unreasonably restrict or harm free competition, seeking that conditions be imposed on the parties to ensure competitiveness in the marketplace, or seeking a partial or complete divestiture of the concentration (or both).
Panama’s economy is expected to grow at a moderate and sustainable rate, despite the perceived reputational damage to the financial and legal services industries. On this matter, the government has countered these issues by cooperating and aligning with international standards and thus making firm commitments to creating a more transparent environment for foreign investors. For example, the government has committed to adopt data-sharing arrangements consistent with US FATCA law and the OECD’s Common Reporting Standards, and has implemented several strict anti-money laundering regulations applicable to both the financial and non-financial sectors. Multinational corporations, regional conglomerates and private equity firms continue to seek and take advantage of the country’s unique geographical position, its free market system and investor-friendly climate, will cause the prevalence of cross-border M&A in Panama to increase. A new recently adopted bankruptcy law (similar to Chapter 11 under US federal bankruptcy laws) will also likely spark interest in distressed assets and companies. Undoubtedly, Panama will continue on the spotlight for foreign investors, and the body of legislation governing M&A in Panama will continue to evolve as cross-border transactions become more complex.
1 Andrés N Rubinoff is a senior international associate at Arias, Fábrega & Fábrega. The author would like to thank Mariam Dadabhai, an associate at Arias Fábrega & Fábrega, for her contribution to this chapter.
2 Fitch ratings: ‘Fitch: Panama Economy is Robust: Leaks Pose Reputational Risk’: www.fitchratings.com/site/pressrelease?id=1002505.
3 Metro de Panamá, ‘Metro de Panamá participa en el foro público para el Estudio de Impacto Ambiental de la Línea 3 del Metro y 4to Puente’: www.elmetrodepanama.com/1579-Metro-
4 Corinne Deléchat and Svetlana Vtyurina, IMF Western Hemisphere Department, ‘Panama: Growth to Remain Buoyant’, 28 March 2013: www.imf.org/external/pubs/ft/survey/so/2013/car032713a.htm.
5 La Estrella de Panamá, ‘First Quantum extiende oferta’, 1 March 2013: laestrella.com.pa/economia/first-quantum-extiende-oferta/23474063. La Estrella de Panamá, ‘Retos de First Quantum en el Proyecto Cobre Panamá’, 31 March 2013: laestrella.com.pa/economia/retos-first-quantum-proyecto-cobre-panama/23477941.
6 IMF, ‘Panama: Staff Report for the 2014 Article IV Consultation’, 24 April 2014: www.imf.org/external/pubs/ft/scr/2014/cr14157.pdf.
7 World Bank Group, ‘Doing Business 2016 Measuring Regulatory Quality and Efficiency’: www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-Reports/English/DB16-Full-Report.pdf.
8 Ministry of Commerce and Industries, ‘Más empresas multinacionales se instalan en Panamá’, 11 March 2015: www.mici.gob.pa/detalle.php?cid=20&id=4440.