I OVERVIEW OF M&A ACTIVITY

Costa Rica is a development success story in many respects. There has been steady economic expansion for more than a quarter of a century, and a stable democracy has been in place since 1949, allowing the country to enjoy growth for several years thanks to a strategy of outward-oriented growth based on openness to foreign investment and gradual trade liberalisation.

Costa Rica is also a global leader with regard to its environmental policies and accomplishments, which have helped the country to build its green trademark by promoting forest and biodiversity conservation, and the use of renewable energy sources.

The Costa Rican Investment Promotion Agency (CINDE) is a private, non-profit and non-political organisation appointed by the government to promote foreign investment. It has attracted more than 200 companies since it was formed more than 30 years ago, including worldwide leaders such as Intel, Hewlett-Packard, Procter and Gamble, to name but a few. More recently, Amazon, McKinsey & Co and Microsoft have announced that they intend to expand their operations here.

The Social Progress Imperative global index ranked Costa Rica 28th of 128 countries in 2017. Of the 22 countries in Latin America included in the report, Costa Rica ranks second after Chile (25th overall) as the countries with the greatest social progress in the region, well ahead of some of the major regional players.2

According to the 'Global Competitiveness Report' of the World Economic Forum, Costa Rica was catalogued as an economy transitioning from Stage 2 (efficiency-driven economies) to Stage 3 (innovation-driven economies). The country was ranked 47th of 138 on the Global Competitiveness Index for 2017 – second in Latin America after Chile, and ahead of Panama and Mexico compared with 2016.3

Costa Rica's gross domestic product (GDP) per capita has tripled since 1960, and its growth averaged 4.5 per cent between 2000 and 2013, as compared to the regional average of 3.8 per cent for the same period. According to World Bank information, the country's GDP in 2016 was US$57.44 billion, with economic growth of 4.3 per cent. Inflation for 2016 was at 2.3 per cent.

Costa Rica's economy is predominantly services-based. The services export industry includes business process offshoring (BPO), information technology offshoring and shared services. BPO itself covers a wide range of services. There are many large corporations with BPO operations in Costa Rica, including Hewlett-Packard, Intel, Bridgestone, Amazon, Procter and Gamble, Western Union, Emerson Electric and IBM. Some companies combine BPO services with manufacturing or repair facilities. Costa Rica's economy also has a thriving medical device manufacturing industry that includes Baxter, Covidien, Abbot, Boston Scientific, Allergan and St Jude Medical.

Exports in 2016 grew by 7.5 per cent, as compared with 2015. According to data from the World Bank, exports of goods and services in Costa Rica represent 32 per cent of the country's GDP. In 2016, exports to European and Asian countries thrived, with the European Union market experiencing a growth of 15 per cent, while exports to European countries grew by 24 per cent and to Asian countries by 5.3 per cent.

In 2016, 41 per cent of exports from Costa Rica were to the United States of America, followed by Nicaragua (6 per cent), the Netherlands (6 per cent), Panama (6 per cent), Belgium (5 per cent) and Guatemala (5 per cent).

The Costa Rican M&A market was equally as active in 2017 as in 2016 (based on data available at the Commission for Competition Promotion (Coprocom)). Consumer and service sectors were the main drivers.

During 2017, multinational firms continued to purchase medium-sized companies to position themselves in the Central American market. There were also cases of local and Central American groups buying competitors to strengthen their market presence. Transactions during 2017 continued to focus on medium-sized enterprises.

II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A

Costa Rica is a civil law country. Case law is only relevant in the interpretation of the law.

The Commerce Code (Law No. 3284 of 30 April 1964) regulates mercantile (commercial) companies in general. From a corporate law standpoint, M&A are contemplated in the Commerce Code.

Costa Rican competition law is set out in the Law for the Promotion of Competition and Effective Consumer Protection (Law No. 7472 of 19 December 1994) (CR-LPC).

Chapters 3, 6 and 7 of the first book of the Commerce Code regulate the two most common corporate forms: corporations and limited liability companies. These chapters include company acquisition-related regulations, but there is no specific 'acquisition' title or chapter. The regulations mainly concern the transfer of shares or equity participations and associated requirements.

The purchase of ongoing businesses is different from a company acquisition, and is regulated in Chapter 3 (Title 1) of the second book of the Commerce Code (Articles 478 and 489). Chapter 3 establishes requirements for the transfer of ongoing businesses, including publication (for three consecutive days) in the official newspaper and giving notice to the enterprise's creditors so that they have an opportunity to oppose the acquisition or exercise their rights for a period of 15 days. Payment of the purchase price, according to Article 480, is not to be made before the 15-day period expires and until liquidation of accounts payable is made. Escrow of funds is commonly used for this purpose.

If the formalities established in Chapter 3 are not met, the transaction will be absolutely void (for any eventual rights of third parties or creditors of the acquired ongoing business) and payments made to the creditor will not be considered valid.

Regarding mergers, Chapter 10 of the first book of the Commerce Code, 'Mergers and transformations', includes a very basic set of regulations regarding the legal nature of a merger and the formal requirements to complete it. Merging entities may either form a new company or be merged via 'absorption' (acquisition), in which only one of the entities survives.

From a corporate law standpoint, the requirements to complete a merger are simple: a pre-merger project or agreement, approval via extraordinary shareholders' meetings (of all entities involved) and publication of an extract of the merger approval in writing or in a deed in the official newspaper. The merger will be effective a month after its publication and registration if no third party opposes it. In principle, recordable assets will be transferred to the resulting or surviving entity.

Competition law requirements to complete mergers, company acquisitions and purchases of ongoing businesses are described in the next section.

III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT

As indicated, Costa Rican competition law is set out in the CR-LPC.

Preliminary merger control for transactions of a certain volume (over a threshold of US$15 million) or of special relevance to the national market is mandatory.

A merger or an acquisition may be considered a 'concentration' under Article 16 of the CR-LPC, so even though parties are free to consolidate a merger or an acquisition, they are required to file a notification or previous communication to the Coprocom if meeting the criteria established in the CR-LPC.

Merger and acquisition control in Costa Rica uses a short authorisation proceeding. If the preliminary merger control notice is not sent, the Coprocom may challenge a merger proven to qualify as a concentration by opening a penalising proceeding.

Mergers or acquisitions involving regulated entities (banks, public companies, financial entities, pension funds, companies managing funds of third parties and insurance companies), in addition to the previous communication to the Coprocom, must obtain the applicable approvals of the Securities Supervisory Agency (SUGEVAL), the Private Pension Funds Supervisory Agency (SUPEN), the General Insurance Supervisory Agency (SUGESE), the General Telecommunications Supervisory Agency (SUTEL) or the Financial Entities Supervisory Agency (SUGEF), as appropriate.

According to the amended version of Article 16 CR-LPC, a concentration is defined as a:

[...] merger, sale of business premises, or any other act or contract by which companies merge, form partnerships, acquire shares, share equity, form trusts, merge or combine management, representation or general assets; made between competitors, suppliers, customers or other operators who have been independent in respect to each other, and result in the acquisition of economic control by one over the other or others, or in the formation of a new economic agent under joint control of two or more competitors, and any transaction in which any natural or legal person, public or private, acquires control of two or more independent economic agents, actual or potential competitors.

The enactment of the Tax Collection and Management Act and the General Tax Procedure Regulations are discussed below. Although specific merger and acquisition regulations are not contained in either set of Regulations, there are indirect applications or consequences to mergers, company acquisitions and the purchase of ongoing businesses.

IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS

Acquisitions, expansions and ventures took place in Costa Rica in several sectors during 2017. While US companies and European multinationals were the main participants, Latin American groups were also involved.

Costa Rica continues to pursue high-quality foreign investment. CINDE and Procomer lead Costa Rica's investment promotion efforts. CINDE has focused on creating clusters of related businesses, successfully targeting potential investors in the areas of medical devices, services (shared services, BPO, global in-house centres) and advanced manufacturing.

V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES

The following is a summary of relevant 2017 transactions, expansions and projects in Costa Rica:

Acquirer Transaction Target(s) Sector
HAPP Investors Ltd Acquisition SHI Hospitality Holdings Costa Rica Tourism
Petróleos Delta CR SA Acquisition Total Petróleo CR SA Consumer
3-101-731314 subsidiary company of Cuestamoras Salud Costa Rica SA Acquisition Farmacias La Bomba Consumer
Abonos del Pacífico SA Acquisition Fertilizantes NORDIC de Costa Rica SA Agriculture
Inversiones Farmacéuticas Santa Lucía SA Acquisition Fralni del Oeste SA, FSL and Farmacias Chavarría SA Consumer

VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS

Acquisition financing is available for transactions. The most common funding structures, regardless of the acquirer, are bank lending, corporate debt, capital increases (private placement of shares of stock), and securitisations or security trust agreements.4

Withholding taxes are an important issue to take into account in establishing funding structures and schemes, as these may apply if interest is paid to a bank domiciled abroad.

M&A financing has mainly come from abroad. As has traditionally been the case, M&A are still financed in the acquirer's market, or through regional or global banks. However, regional banks are becoming more involved in M&A transactions.

VII EMPLOYMENT LAW

No recent relevant amendments or modifications to Costa Rican labour regulations affecting mergers or acquisitions have been issued. The only applicable regulation in the Code of Labour Law is still the employer substitution rule, according to which both parties involved in an acquisition (or employer substitution) will be jointly liable for six months after the substitution is completed or verified regarding employees' termination rights and benefits. Once this period expires, the new employer remains solely liable for termination rights and benefits.

VIII TAX LAW

Except for a few exceptions discussed below related to tax auditing, the tax system has not been recently amended. The country's tax regulations establish that residents and corporations are taxed only for income earned in Costa Rica. The following is a summary of the main applicable taxes.

i Income tax

This applies to individuals as well as legal entities for income originating from a Costa Rican source. Taxable income is based on net income. Capital gains are generally not subject to income tax, except when the transfer activity is regular or when transferring assets that were subject to depreciation. In the latter case, the applicable rate is 30 per cent on the capital gain. Withholding taxes apply, inter alia, to dividends (15 per cent), interest (15 per cent), royalties (25 per cent) and fees (25 per cent).

ii Annual property tax

Property tax is rated at 0.25 per cent of the value of a property, and may be paid annually, by semester or by quarter depending on the procedures established by the local government (municipality).

iii Transfer taxes

There is a 1.5 per cent real property transfer tax and a 2.5 per cent vehicle transfer tax. This tax is based upon the higher of the registered value or the deed value at the time of sale.

iv Stamp duty

This applies to all contracts and agreements at a rate of 0.5 per cent of the documents' economic value.

v Sales tax

This is imposed on certain taxable transactions at a rate of 13 per cent and is paid monthly.

After the enactment of the Tax Collection and Management Act in October 2012, the General Tax Procedure Regulations were approved. Although specific mergers and acquisitions regulations are not contained in the General Tax Procedure Regulations, the Regulations are broad and complex, and they contain stricter rules and new capacities for the Tax Administration that should orient acquisition or merger processes during due diligence and implementation.

The rule contained in the amended Code of Policies and Procedures Tax is that assets will be subject to the companies' enforceable tax debts even after a transformation, merger or company acquisition process, or the transfer of ongoing businesses. For assets to be subject to the companies' enforceable tax debts after a transformation, merger, acquisition process or the transfer of ongoing business process, the debt has to be enforceable prior to the process.

Also important to take into account is that the Tax Collection and Management Act also imposes transfer tax (as described above) on 'indirect transfers' (when a company holds real properties and vehicles, and the company is transferred to new group of shareholders as a whole). In principle, transfer tax does not apply to mergers: the application of transfer tax has not been yet been interpreted by the Tax Administration in connection with acquisitions.

No other recent relevant amendments or modifications to the Costa Rican tax regulations affecting mergers or acquisitions have been issued.

IX COMPETITION LAW

As outlined in Section III, Costa Rican competition law is set out in the CR-LPC. Mergers, company acquisitions or the purchase of ongoing businesses may be interpreted by the Coprocom as a 'concentration' under Article 16 of the CR-LPC, so preliminary merger control for transactions of a certain volume or special relevance is mandatory.

Other agencies may also exercise control over mergers, acquisitions or other relevant transactions in connection with public companies, financial entities, pension funds, companies managing funds of third parties and insurance companies, based on the regulations issued by the National Council of Supervision of the Financial System (CONASSIF). These agencies are SUGEVAL, SUPEN, SUGESE, SUTEL and SUGEF.

X OUTLOOK

Costa Rica has continued to experience economic growth during the past year. The country presents an attractive combination of skills and opportunities, and attracts export and services-oriented foreign investment. Its attractiveness has started shifting to emerging areas such as, inter alia, IT, knowledge processes, finance and accounting, which require sophisticated skills and technological infrastructure.

Experts consider recent developments in the Costa Rican services market to be part of its natural evolution.5 Other developments include the establishment of shared service centres and manufacturing facilities outside the Greater Metropolitan Area, as well as the establishment of energy, infrastructure and tourism projects, creating continuous M&A opportunities for sophisticated investors and investment banking firms.

Costa Rica continues to evolve as a destination for investors with strong promotion and protection programmes and friendly policies. Even though the size of the Costa Rican and Central American market is not as significant as other countries in Latin America, in terms of retail operations, its pursuit of growth will continue drawing multinationals that feel comfortable with the above-mentioned mixture of skills and opportunities.


Footnotes

1 John Aguilar Quesada and Marco Solano are partners at Aguilar Castillo Love.

5 The World Bank. 'Costa Rica – Public Expenditure Review: Enhancing the Efficiency of Expenditures': https://openknowledge.worldbank.org/handle/10986/8122.