I OVERVIEW OF M&A ACTIVITY
During the past year, the Ecuadorian economy has changed course and begun attracting foreign direct investment (FDI); the FDI registered by the Central Bank of Ecuador in fiscal year 2018 totalled US$1.401 million, which reflects an increase of 126.5 per cent compared with the FDI received in 2017. During 2018, FDI was invested in the following industries:
- mining (US$742 million);
- services (US$187.3 million);
- commerce (US$182.7 million);
- manufacturing (US$103 million);
- construction (US$86.8 million);
- agriculture (US$59.3 million);
- transportation; and
- storage and communications (US$38.7 million).
The new government came into power in May 2017, and has been working on policies to improve FDI. At the end of December 2017, for example, the government defined the promotion of investments as a 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 M&A 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 M&A 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 its administrator, all as a means of strengthening the stock market. These measures will 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.
In March 2019, the Directory of the International Monetary Fund (IMF) approved a financing agreement with Ecuador of up to US$4,200 million. The agreement requires Ecuador to implement several legal amendments to its framework and change several policies, including, among other things, a reduction of the country's overall foreign debt, a reduction of the public sector deficit, tax reforms, privatisations, returning its autonomy to the Central Bank and labour reforms.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
Generally, an M&A transaction will be governed by the Civil Code (Private Law Rules), the Companies Law, the Organic Law of the Internal Tax Regime and its regulations and, when applicable, the Organic Law for the Regulation and Control of Market Power.
For M&A purposes, the Companies Law regulates the merger procedure. Pursuant to the Companies Law, there are two types of mergers: when two or more companies join to form a new one that acquires their rights and obligations (Article 347 of the Companies Law), commonly known as a merger; and when one or more companies are absorbed by an existing one, commonly known as a merger by absorption.
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:
- summons to the extraordinary general shareholders' meetings for both the absorbed and the absorbing entities;
- issuance of resolutions by the extraordinary general shareholders' meetings 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 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 sought through different contractual vehicles, but generally, these contracts will either agree to the 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 the acquisition of business assets and liabilities.
These contracts will generally be governed by the Private Law Rules and, depending on the industry or sector, will add additional regulatory conditions as required by the relevant law.
i Acquisition of shares
If stocks are listed on the stock market, they can only be negotiated in the stock exchange through brokers. The only exceptions are transfers of shares made by virtue of mergers, demergers, inheritance, legacies, donations and liquidations of community properties or de facto business associations.
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 assignor and 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 or she makes.
- The lack of presentation of this information (or the presentation of erroneous data) is 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.
ii Acquisition of assets
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.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND
On 28 December 2017, the Organic Law for the Reactivation of the Economy was enacted, which includes certain measures to reactivate the economy. The Law amends the Companies Law and introduces the procedure for the transfer of the legal domicile of a foreign company to Ecuador; it also approves the validity of shareholders' agreements, which establish conditions for a transfer of shares.
On 21 August 2018, the Law for Productive Promotion, Investments Attraction and Generation of Employment was enacted with the main purpose of making the economy dynamic, and promoting investment and employment as well as long-term fiscal sustainability.
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 Doing Business 2019 publication, Ecuador is ranked as the 123rd country out 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 the food, animal products, agricultural goods, banking and insurance, beer and beverage, and cement and steel-producing markets have been the main recipients of foreign investment through M&A transactions in 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:
- Nutreco Investments BV and Hendrux Genetics BV acquired 80 per cent of Macrobio SA, a laboratory dedicated to shrimp farming;
- Socofar SA, a subsidiary of Fomento Económico Mexicano, SAB de CV (FEMSA), acquired 100 per cent of one of the key players in the retail pharmaceutical business, Corporación Grupo Fybeca SA GPF;
- Grupo Familia, through its subsidiary Productos Familia Sancela of Ecuador SA, acquired 100 per cent of Industrial Papelera Ecuatoriana SA for approximately US$36 million. This operation required the authorisation of the Superintendency of Market Power Control;
- Compañía de Petróleos de Chile Cope SA acquired the lubricants and fuels business of Exxon Mobil Ecuador through its subsidiary, Organización Terpel SA;
- 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 of the social capital of Terrafertil;
- InRetail Perú Corp acquired the pharmaceutical distributor Quicorp SA for US$583 million;
- Heineken International BV acquired the majority of Biela y Bebidas del Ecuador SA, a company dedicated to the production of beer products, including key brand Biela;
- Dicomtriz SA acquired the Amazonas Gas Station for US$10,561,332 million; and
- 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
M&A transactions are generally funded either by companies' own funds when multinationals are involved, or international private banks and multilateral development banks, together with their private branches, such as IDB-Invest. The agreement with the IMF will encourage more foreign lenders to participate in these transactions.
VII EMPLOYMENT LAW
M&A transactions generate labour issues that must be addressed during negotiations. If a transaction is made through the purchase of shares, there is no change of employer and the working relationship is maintained with the employees; however, some legal scholars consider that Article 171 of the Labour Code is also applicable, and that employees have the option to terminate their contractual relationship as well; this is a much-debated subject. 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 a 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.
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 employees. 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.
The IMF agreement requires major amendments to the employment framework. There are ongoing talks regarding the depth of such amendments; however, it is expected that these amendments will make the current rigid labour regime more flexible.
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 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 a 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 a merger is also tax-exempt but not deductible. Any personal property transfer taking place as a result of a merger would not be subject to VAT. Likewise, the transfer of real 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, or 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 in general it has been combating tax havens. One of the most recent examples, in February 2017, saw Ecuadorians vote to bar politicians and civil servants from having assets, company interests 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 Convention on Mutual Administrative Assistance in Tax Matters. As a party to the 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 Organic Law for the Reactivation of the Economy, and the Law for Productive Promotion, Investments Attraction and Generation of Employment, 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.
As previously stated before, the IMF agreement also requires major tax reforms. While non have been approved yet, the President has already announced the elimination of the green tax because it had not fulfilled its tax purpose.
IX COMPETITION LAW
Starting from 13 October 2011, Ecuador's competition regime was implemented through the enactment of the Organic Law for the Regulation and Control of Market Power (LORCPM). The SCPM is the entity in charge of overseeing compliance with the LORCPM.
The SCPM, as provided in the LORCPM and its regulations, has broad powers, including:
- investigating and imposing sanctions related to antitrust matters and violations, restrictive practices and market power abuse;
- approving conditioning or rejecting economic concentrations (mergers); and
- investigating and imposing sanctions related to unfair trade practices.
Operations of economic concentration are those operations that have the potential to affect the structure of a market by limiting the number of competitors or the means of production.
i General legal regime applicable to mergers
The LORCPM determines that operations of economic concentration include but are not limited to the following:
- full transfers of the assets of a merchant;
- the direct or indirect acquisition of the property or of any other right over the shares or interests in the capital or securities that grant any type of right to be converted into shares or interests in the capital, or to have any type of influence in the decisions of the person that issues them, when such acquisition grants to the acquiring party the control of or a substantial influence over that person;
- economic concentrations through the appointment of common managers or directors; and
- any other agreement or act that transfers to a person or to an economic group the assets of an economic operator, or that grants such person or economic group decisive control or influence in the adoption of the decisions of the ordinary or extraordinary management of an economic operator.
ii Thresholds and conditions
Certain operations of economic concentration require prior approval from the SCPM before taking effect. Prior approval is required in the following cases:
- when the total business volume in Ecuador of all the transaction participants, considered jointly, in the previous fiscal year of operation exceeds the amount of unified basic remunerations (RBU) set forth by the Regulating Board as follows:
- for operations involving financial institutions and stock market entities, 3.2 million RBU, which in 2019 represent US$1.260 million;
- for operations involving insurance and reinsurance companies, 214,000 RBU, which in 2019 represent US$84,3 million; and
- for operations involving economic operations not included in (i) and (ii), 200,000 basic unified salaries (US$78,8 million); and
- when a transaction involves economic operators with a combined market share of 30 per cent or above in the relevant market of products or services.
If the conditions described above are not met by the parties to a transaction, or by the transaction itself, no prior approval by the SCPM is necessary. Nevertheless, the SCPM, may, ex officio or at the request of an interested third party, review the transaction.
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 LORCPM 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 to 12 per cent of the turnover in the fiscal year previous to the one when an infraction is determined. There are also substantial monetary fines for the legal representatives, directors and officers of a company involved in an infraction.
During 2018, the SCPM investigated 31 cases, 24 of which were opened during the course of the year and seven of which were originally opened in 2017. Of the 24 cases opened during 2018, 15 ended with an authorisation of the transaction without any type of remedies.
The following, among other measures, will undoubtedly contribute to an increase in M&A activity in the next few years in Ecuador:
- the Organic Law for the Reactivation of the Economy, the Law for Productive Promotion, Investments Attraction and Generation of Employment, and the IMF agreement, the laws that are expected to be sent to the National Assembly to attract FDI;
- the government's economic plan;
- the campaign announced by the Minister of Foreign Trade and Investment to make Ecuador a new investment destination; and
- the liberalisation of air transport.
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.
We also expect that the labour and tax reforms required by the IMF agreement will also pave the way for more M&A transactions in Ecuador.
1 Boanerges H Rodríguez Velásquez is a senior associate at Coronel & Pérez.