I OVERVIEW OF M&A ACTIVITY
During the past year, the Ecuadorian economy has attracted foreign direct investment (FDI)at a level well below that of the rest of the countries in the region; the FDI registered by the Central Bank of Ecuador totalled US$560.6 million, which reflects a decrease of 27 per cent compared with direct foreign investment received in 2016. The four main countries from which Ecuador receives foreign investment are China, Spain, the United States and the Netherlands, which account for around 80 per cent of the flows.
During the years 2013 to 2017 inclusive, FDI, both in domestic companies and in branches of foreign mercantile companies in the country, reached a total of approximately US$3.78 billion, an annual average of US$755.26 million.2 During the past year, the sector that received the most FDI was manufacturing, with an investment inflow of approximately US$151 million.
In recent years, Ecuador's FDI has represented less than 1 per cent of gross domestic product. In comparison, other countries in the region have been receiving an average of four times more direct foreign investment.
According to information provided by the Superintendency of Companies, there were 33 mergers and 13 splits or demergers in 2017. So far in 2018 there have been nine mergers and four splits or demergers. However, this data is not complete because not all acquisitions require prior approval from the Superintendency of Control of Power of Market, and also because in many cases the acquisitions are of shares and not mergers proper.
The Ecuadorian government that came into power in May 2017 has been working on policies to improve openness to FDI. At the end of December 2017, for example, the government defined the promotion of investments as key State policy, for which President Lenin Moreno created, through Executive Decree 252, the Strategic Committee for the Promotion and Attraction of Investments.
On 2 April 2018, President Moreno presented the general outline of his economic plan, which consists of four main axes and 14 measures. The most important of these in relation to mergers and acquisitions are measures 6, 7 and 8, which are intended to grant income tax and foreign exchange tax benefits for new investments. The government will work on a new regulatory framework to encourage the financing of investment credits by international banks; this will undoubtedly help reactivate the local mergers and acquisitions market. The government will also seek to rationalise both the costs of stock transactions and the statute that holds the shareholders of a company responsible for the actions of the administrator, all as a means of strengthening the stock market. These measures would help strengthen the concept of limited liability in mercantile companies – a key concept that was harmed by the abusive application of the Organic Law for the Defence of Labour Rights, the negative impact of which was notorious in the stock market.
The Central Bank of Ecuador expects the economy to grow by 2 per cent. For its part, the Community of Latin American and Caribbean States (CELAC) has predicted that economic growth in Brazil will trigger regional growth and estimates a 1.3 per cent growth for Ecuador. It is to be expected that this growth will have a positive impact on the M&A market.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
Depending on the type of company and the sector of the economy in which it operates, different regulations will apply to a merger. The Companies Law, the Organic Law of the Internal Tax Regime and its regulations apply to all merger and acquisition processes. Depending on the volume of the operation and the industry or sector, the Organic Law for the Regulation and Control of Market Power may also apply.
The Companies Law is the main statute that regulates mergers and acquisitions. Two types of mergers exist in Ecuador: (1) when two or more companies join to form a new one that acquires its rights and obligations (Article 347 of the Companies Law); and (2) when one or more companies are absorbed by an existing one.
In a merger, tangible or intangible assets can be transferred at their book value or at their market value. The market value of the tangible and intangible assets is determined by a shareholders' meeting, based on an independent appraisal.
Generally, a merger involves the following steps:
- publication of the call for extraordinary general shareholders' meetings for both the absorbed and the absorbing entities;
- holding the shareholders' meetings to issue resolutions regarding the merger of the company, in the case of the absorbing entity, and the dissolution, in the case of the absorbed entities. The shareholders approve the merger and the amendment of the by-laws;
- filing the public deed of merger before the Superintendency of Companies, Securities and Insurance (SCSI), which will include the approved merger balance sheet;
- an opposition period (six working days) starting with the publication of announcements for three consecutive days, to allow for the opposition of any party that might consider itself affected by the dissolution;
- registration of the SCSI's Merger Approval Resolution at the Mercantile Register and annotations with the notaries;
- other publications and actions related to the finalisation of the approved dissolution;
- cancellation of the absorbed entity's tax identification number and its registrations at other government agencies; and
- other publications and actions related to the finalisation of the approved merger, including updating the information regarding the absorbing entity's capital at the Internal Revenue Service and other government agencies.
The acquisition of an existing business can be done as follows:
- acquisition of the shares (in the case of a corporation or public limited company) or share interests (in the case of a limited liability company); or
- acquisition of business assets and liabilities.
If stocks are listed on the stock market, then they can only be negotiated in the stock exchange through brokers. The only exceptions are the transfer of shares made by virtue of mergers, demergers, inheritance, legacies, donations and liquidations of community properties or de facto business association.
Traditionally, the Company Law did not contemplate the possibility of establishing additional limits to the trading of shares. However, since the amendment of the Company Law by the Organic Law for the Reactivation of the Economy of 28 December 2017, now the shareholders of a company can enter into shareholder agreements establishing additional conditions for the transfer of shares.
The second option – the acquisition of business assets and liabilities – may or may not generate the payment of various taxes. For example, if what is acquired is real property, the operation will be highly taxed by municipal and state taxes. On the other hand, if the operation only involves movable property and intellectual property rights, it will not be taxed.
In general terms, unless a shareholder agreement is in place, a transfer of non-listed shares must comply with the Companies Law, as follows:
- The assignee must receive the stock certificates that contain the shares being transferred, with the respective assignment signed by the assignor. The assignment notice can be delivered in a separate document, attached to the stock certificate.
- Both the assignor and the assignee must inform the legal representative of the local company whose shares are being transferred about the respective share transfers, by means of a joint communication signed by both, or through separate communications.
- The legal representative of the local company must register the respective share transfers on the company's shares and shareholder ledger.
- The local company's legal representative must electronically notify the SCSI about the share transfers that have been carried out.
- The local company must issue new stock certificates at the request of the assignee. For that purpose, the stock certificates that are transferred shall be handed in for their annulment. The assignee can also choose not to request the issuance of new stock certificates and to keep the assigned stock certificates.
- Compliance with the applicable rules for the declaration and payment of income tax on the transfer of shares or participations.
- When Ecuadorian residents and effective Ecuadorian beneficiaries make direct or indirect disposals through non-resident companies, they must declare the income obtained, the expenses attributable to said income and the profits or losses produced by said operations.
- In the case of operations carried out by non-residents of Ecuador, it is the substitute's obligation, namely the company whose shares are being negotiated, to declare and pay the income tax for the sale of shares.
- When a purchaser of shares or rights representing capital is a tax resident in Ecuador and at the same time a withholding agent, he or she is liable for withholding tax on the payment he makes.
- The lack of presentation of this information (or the presentation of erroneous data) is be sanctioned with a fine of 5 per cent of the real value of the transaction.
The share participations issued by limited liability companies are not freely assignable or transferable as is the case for stocks issued by corporations. They can be transferred to another partner in the company or to third parties only with the unanimous consent of the partners. The transfer must be executed through a public deed and registered in the company's ledger.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
On 28 December 2017, the Organic Law for the Reactivation of the Economy was enacted, which includes certain measures to reactivate the economy. In the corporate sphere, the procedure for the transfer of the legal domicile of a foreign company to Ecuador was introduced; the law also expressly established the validity of the shareholders' agreements that establish conditions for the transfer of shares. Before this legal reform, there was no uniform view regarding the validity and enforceability of these kinds of agreements.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Buyers in the process of acquiring companies in Ecuador are often subsidiaries of foreign companies. Many of the large transactions that take place in Ecuador are financed by the purchasers or by foreign banks; it is not common for local banks to be involved in M&A processes.
In the World Bank's publication Doing Business 2018, Ecuador is ranked as the 118th country of 190 economies as regards the ease of doing business. Foreign investors often struggle with bankruptcy proceedings, for instance, which can be complex and lengthy.
Players in markets such as food, animal products, agricultural goods, banks and insurance companies, beer and beverage industries, cement and steel producing companies, have been the main recipients of foreign investment through M&A transactions in the recent past. During the past year, manufacturing was the sector that received the most foreign investment.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
The most significant transactions during the past few years include the following:
- Tevcol purchased the assets of the securities transport unit of the G4S Group.
- Grupo Familia, through its subsidiary Productos Familia Sancela of Ecuador SA, acquired 100 per cent of the shares of Industrial Papelera Ecuatoriana SA (Inpaecsa) for approximately US$36 million.
- Coveris Holding SA acquired 50 per cent of the remaining shares in the company Chemplast del Sur SA. This operation required the authorisation of the Superintendency of Market Power Control.
- Compañía de Petróleos de Chile Cope SA, through its subsidiary Organización Terpel SA, acquired the lubricants and fuels business of Exxon Mobil Ecuador.
- Zurich Insurance Group signed an agreement with QBE Insurance Group Limited to acquire the operations of the latter in Argentina, Colombia, Ecuador, Brazil and Mexico for US$409 million.
- Nestlé SA acquired the majority in the social capital of the company Terrafertil.
- InRetail Perú Corp acquired the pharmaceutical distributor Quicorp SA for US$583 million.
- Corporación Multiinversiones acquired 50 per cent of the shares held by a group of investors in the company Procesadora Nacional de Alimentos Pronaca CA.
- The company Dicomtriz SA acquired the Amazonas Gas Station for US$10,561,332 million.
- On 24 August 2017, the sale of the production plant of Ambev Ecuador SA, a subsidiary of AB InBev, to the Ecuadorian consortium CEREC Holding Company SA was approved by the Superintendency of Market Power Control (SCPM) as part of the divestment process that AB InBev must complete for its global merger with SABMiller.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
There are several ways to finance mergers and acquisitions. However, what is most common in Ecuador is that the finance comes from abroad or a company's own funds; local banks are not active participants in these operations. It is possible that with the announcement of the government's economic plan and the laws that are scheduled to be sent to the National Assembly, foreign banks will have a greater role in M&A operations.
VII EMPLOYMENT LAW
M&A operations generate labour issues that must be addressed during negotiations. If the transaction is made through the purchase of the shares, there is no change of employer and the working relationship is maintained with the employees. If after the purchase the buyer terminates the contracts of certain workers, the company is obliged to provide compensation in the form of severance payments.
On the other hand, if the transaction is made through the acquisition of assets or business units of a company, Article 171 of the Labour Code comes into effect, and the buyer must assume the responsibility of its predecessor as employer with respect to the workers at the business unit. Note that if a worker decides not to continue the employment relationship with the new employer, the employer must compensate him or her with a severance payment.
Finally, in merger processes, all labour contracts are maintained and the absorbing company will be the new employer of the workers of the absorbed company. If two merging companies are liquidated and a new company is created, the new company will be the new employer of the workers of the two companies that have merged.
Generally, once an employment agreement is terminated unilaterally by the employer, a severance payment is due to the employee. The amount of the severance payment will depend on the last compensation and the seniority of each employee.
Another important aspect regarding employment legislation is that there are specific contractual modalities that apply for certain industries, such as banana production, tourism and floriculture.
VIII TAX LAW
Nearly all payments made by corporations and individuals are subject to withholdings on account of taxes. The payer is responsible for withholding the appropriate amount, providing tax withholding certificates to the payee, filing a report of withholdings, and paying the amounts withheld within the following month. Payments made abroad – with some exceptions, such as dividends and interests – are subject to withholding at a rate of 25 per cent pursuant to Article 39 of the Internal Tax Regime Law. For instance, royalties paid abroad are subject to a withholding of 25 per cent unless they are reduced under a tax treaty or increased to 35 per cent if the recipient is in a tax haven or low-tax jurisdiction.
Dividends paid to a resident or non-resident corporation from another resident corporation out of profits that have been subject to corporate income tax are exempt, provided that the recipient does not reside in a low-tax jurisdiction or in a tax haven; otherwise, a withholding of 10 per cent has to be made.
Payments made abroad for interest on foreign loans registered at the Ecuadorian Central Bank (ECB) are tax-deductible but are not subject either to income tax or to withholdings on account of taxes in Ecuador, as long as that interest does not exceed the interest rate fixed by the board of directors of the ECB as of the date on which the loan was registered or registration was renewed. If the interest rate of the loan exceeds the ECB's interest rate, a withholding of 25 per cent must be made on the excess.
Income (capital gains) generated by the direct or indirect transfer of shares is no longer tax-exempt, since the tax laws were amended in 2015. However, share transfers are exempt from VAT.
Transfers of assets and liabilities that take place as a result of a merger are exempt from income tax. The increase or reduction in the value of the shares that may take place as a consequence of the merger is also tax-exempt but is not deductible. Any personal property transfer taking place as a result of the merger would not be subject to VAT. Likewise, the transfer of real estate property would not be subject to VAT or municipal taxes.
One tax implemented since 2008 that still discourages foreign investment is the Overseas Remittance Tax. This is levied on the value of all monetary operations and transactions carried out towards any other country, with or without the intervention of institutions belonging to the financial system. The tax base is the amount of the currency transfer, of the credit or deposit, or the amount of the cheque, wire transfer or draft abroad. The current tax rate is 5 per cent and there are few exemptions.
In the past, Ecuador has not only imposed higher taxes on transactions involving persons located in tax havens, but it general it has been combating tax havens. One of the most recent examples is that, in February 2017, Ecuadorians voted to bar politicians and civil servants from having assets, company interest or capital in tax havens.
Ecuador has been part of the global trend towards greater tax transparency and the fight against tax evasion. In May 2017, Ecuador joined G20 countries, OECD members and other developing countries as a member of the Global Forum on Transparency and Exchange of Information for Tax Purposes. In May 2018, the Director of the Internal Revenue Service announced that Ecuador had become a party to the Multilateral Agreement on Mutual Administrative Assistance in Tax Matters. As a party to this agreement, Ecuador will be able to exchange financial information with 117 countries.
Ecuador has concluded tax treaties with several countries (including Belgium, Canada, Chile, France, Germany, Mexico, Singapore and Spain) to avoid the double taxation of income.
Several tax incentives are set forth in the Production Code, The Law of Public-Private Partnerships and the Organic Law for the Reactivation of the Economy, all aimed at attracting both domestic and foreign investment in certain priority sectors: logistical services, biotechnology, tourism, forestry, etc. A five-year tax moratorium on corporate tax applies to new investments that comply with certain requirements and are located outside the main cities of Quito and Guayaquil. A tax exemption of 10 years applies for investments in some industries. The Law of Public-Private Partnerships includes benefits for foreign investors that become parties to these types of partnerships.
IX COMPETITION LAW
The Organic Law of Regulation and Control of Market Power (the Antitrust Law) was enacted in Ecuador in 2011 and the current control agency is the SCPM.
i Market power
Pursuant to Article 7 of the Antitrust Law, market power 'is the capacity of the economic operators to influence significantly in the market'. The Law seeks to avoid, prevent, correct, eliminate and sanction the abuse of market power by economic operators. The scope of the Law covers all economic operators, individuals or corporations, public or private, national or foreign, for profit or not-for-profit, and that currently or potentially perform any economic activities in Ecuador, as well as the associations they form. It is also applicable to entities that perform economic activities abroad if their acts, activities or agreements produce or might produce adverse effects on the local Ecuadorian market.
For market power analysis, the SCPM will determine the relevant market by looking at the product or service market, the geographical market and the particular characteristics of the sellers and buyers who participate in the market. The SCPM will carefully screen the nature of the investigated conduct, based on their economic and real effects and not merely on their legal form.
Additionally, the Antitrust Law provides the criteria for determining whether an economic operator has market power in a relevant marketplace (i.e., participation in the market, existence of barriers of entry and exit). Abuse of market power is prohibited. This abuse occurs when one or several economic operators, based on their market power, by any means impede, restrict, falsify or distort the competence, or negatively affect economic efficiency or general well-being.
ii M&A and the Antitrust Law
According to the Antitrust Law, M&A transactions are defined as those where there is a change in ownership or control in one or more entities in favour of another. The law requires the approval (clearance) of transactions that meet certain thresholds.
The Antitrust Law sets forth the following clearance thresholds for M&A transactions: (1) operations that involve a combined participation (market share) of 30 per cent or more of a relevant market; or (2) operations of a combined amount exceeding US$1.24 billion in the case of banks, US$82.6 million in the case of insurance companies and US$77.2 million in all other cases.
Depending on the markets in which the M&A transaction is taking place, the approval of specific regulatory agencies (such as the Superintendency of Companies, the Superintendency of Banks, the Hydrocarbons Regulatory and Control Agency, the Mining Regulation and Control Agency, the Telecommunications Regulatory and Control Agency) must be obtained.
As previously indicated, the enactment of the Antitrust Law has completely changed the landscape in Ecuador with respect to large M&A transactions. The need for regulatory approval under many circumstances has increased both the time and cost of closing transactions of economic significance. In addition, a perceived sense of unpredictability that clearance will be granted will remain until there has been sufficient and consistent practice by the regulator.
Violations of the Antitrust Law are severely penalised. Monetary fines range from 8 per cent to 12 per cent of turnover in the fiscal year previous to the one when the infraction is determined. There are also substantial monetary fines for the legal representatives, directors and officers of a company involved in an infraction.
The forecasts that the economy in the region is growing and that the Ecuadorian economy is expected to grow by 2 per cent bodes well for M&A operations in 2018. The Organic Law for the Reactivation of the Economy, the government's economic plan, the laws that are expected to be sent to the National Assembly to attract foreign direct investment, the campaign announced by the Minister of Foreign Trade and Investment to make 'Ecuador a new investment destination', the liberalisation of air transport, among other measures, will undoubtedly contribute to an increase in M&A activity in the next few years.
The strengthening of the principle of limited liability will undoubtedly be an incentive for both local and foreign investors, as will be the guarantee of the continued 'dollarisation' of the economy, which is perceived to bring much-needed stability for long-term investment.
Note that international organisations are working with local experts on general guidelines for a comprehensive reform of the Companies Law with a view to simplifying costs, protecting minority shareholders and allowing new types of companies that are in line with the reality and economic needs of the modern economy. The project can be expected to serve as a model for other Latin American countries that have economies similar to Ecuador and where closed companies that are controlled by family members or by few main shareholders (with little protection for minority interests) are common. The project is expected to be ready by the beginning of 2019.