The Mergers & Acquisitions Litigation Review: Mexico
Mexico has improved its legal system in recent years to become a suitable venue to conduct business and protect investment through deregulation and the execution of bilateral and multilateral agreements on trade and investment. The recent approval of a new free trade agreement with the United States of America and Canada (USMCA) confirms such commitment.
Despite certain advances, it is still a major step to adapt to new market trends and innovation in Mexican mergers and acquisitions (M&A) culture. These trends include departing from older statutes and traditional legal practices and revamping the judicial system to allow more efficient, speedier, and creative judgments. Mexico must transition to a true rule-of-law system that provides equal access to justice for every person and ensures effective redress. If Mexican courts do not evolve and transition to more sophisticated analysis, alternative dispute resolutions mechanisms (and even foreign venues) will continue to prevail in sophisticated transactions in Mexico. Sophisticated M&A transactions are rarely disputed in local courts and arbitration is often the preferred method of dispute resolution.
The volume of litigation related to M&A transactions in Mexico is low. However, in the past few years there has been an increase in M&A transactions, which was followed by a downturn in the Mexican economy that increased the volume of M&A litigation.
Legal and regulatory background
Mexico is a civil law country. Thus, Mexican courts do not follow a stare decisis or precedent doctrine as understood by common law scholars. There are no jury trials. As a general rule, there is no discovery and, although there are oral hearings as part of Mexican proceedings, the legal system still relies heavily on written pleadings and formalities. A change in the administration of justice is emerging via three different avenues:
- oral proceedings;
- effective access to justice (merits over procedural formalities); and
- as part of the effect of covid-19, a necessary transition to online dispute mechanisms.
The main sources of law in Mexico in order of precedence are:
- the Mexican Constitution;
- international treaties;
- statutes, administrative bands and regulations; and
- contracts and rulings.
The interpretation of law is done according to the express text of the law, its interpretation by judicial precedents and general principles of the law.
As a general principle, the Mexican Constitution sets forth a reserve clause whereby the authority not vested in the Federal Congress is understood to be reserved for Mexican states. Commercial law (both substantive and procedural) is under federal jurisdiction. However, an M&A deal must consider federal, state, and municipal laws. Certain types of Mexican entities (civil societies and civil associations) are governed by local civil codes and fall outside the scope of federal jurisdiction and commercial laws.
Some of the main statutes that govern M&A transactions and shareholders matters are:
- the Mexican Constitution;
- the General Law of Commercial Companies (LGSM);
- the Stock Market Law (LMV);
- the General Law of Negotiable Instruments and Credit Transactions;
- the Commercial Code;
- the Federal Civil Code;
- the Foreign Investment Law;
- the Federal Economic Competition Law; and
- the Federal Law for the Prevention and Identification of Transactions with Resources of Illicit Origin.
Other statutes, laws and regulations may apply depending on the industry sector and type of M&A transaction.
Regulators often involved in M&A transactions are the Federal Economic Competition Commission (COFECE) and, in public M&A deals, the National Banking and Securities Commission. Other regulators may be involved depending on the industry sector (telecoms, mining, banking, etc.).
i Common claims and procedure
Shareholders have two types of rights: economic (dividends and distributions) and corporate. Corporate rights subdivide into three:
- governance (the right to call to a shareholders' meeting, prepare the agenda of a meeting and vote);
- surveillance (the right to request information, review the company's operations, review the board of director's performance, approve financial statements, etc.); and
- minority rights that vary depending on the type of entity (the right to call shareholders' meetings, opposition claims, delay voting, claim liability from management, appoint directors or statutory auditors, etc.).
Further, shareholders may execute a shareholders' or operational agreement that contains additional rights and obligations regarding the shareholders. The violation of any of the above-mentioned rights will give legal standing to the shareholders to file a claim or trigger the opposition, separation or other rights set forth in the LGSM.
The shareholders in a limited liability society (SRL) and anonymous society (SA) may be subject to involuntary separation. The grounds for separation for an SRL are established in the LGSM, such as a shareholder using the company for its own business, infringing the by-laws of the company or applicable law, defrauding the company, or the company entering insolvency. In the case of the SA, the grounds for separation may be set forth in the by-laws of the company, on the understanding that the LGSM does not provide an exhaustive list.
Some of the most common and relevant shareholder claims are as follows.
All resolutions adopted in shareholders' meetings are binding for all shareholders, including missing and dissenting shareholders. However, the LGSM provides that shareholders representing at least 25 per cent (20 per cent for Investment Promotion Corporations (SAPIs)) of the shares have the right to file an opposition claim against such resolutions, should they meet the following requirements:
- the claim is filled within 15 days following the shareholders' meeting;
- the claimants did not attend the meeting or voted against the resolution;
- the claim states the violated legal provision or provision of the by-laws; and
- the claimants deposit their shares before a public notary, public broker or a credit institution. The shares will remain in deposit until the trial finishes. A certificate of such deposit shall accompany the claim.
If an opposition claim is filed, the enforcement of the challenged resolution may be stayed by the court until final judgment if the claimants issue a bond for the potential damages that the company may suffer as a result of any stay.
Nullity of shareholders' meetings
While opposition claims are aimed at challenging the resolutions adopted during shareholders' meetings, a nullity claim is aimed to render the shareholders' meeting null and void. Shareholders' meetings must comply with some formal requirements:
- it has to be conducted in the corporate domicile;
- the call for the meeting has to be property performed;
- the call must be signed by the authorised person and contain the agenda; and
- quorum and attendance requirements must be met.
If any of these requirements is not met, the shareholders may claim the nullity of the shareholders' meeting. The Mexican Supreme Court has ruled that the article of the LGSM that provides that the enforcement of the challenged resolution may be stayed applies only for an opposition claim and not for a nullity claim. However, in a nullity claim, the claimants could seek an interim measure regardless of such provision. The statute of limitation for a nullity claim is 10 years. In these claims, the claimants do not need to deposit their shares before a public notary or credit institution.
Claims arising from the by-laws of the company or shareholders' agreements
Not all claims involve a shareholders' meeting. Shareholders may also bring claims based on an alleged violation to their contractual rights as contained in the by-laws of the company or shareholders' agreements. The type of claim will depend on the breached obligation, the defending party (e.g., another shareholder, the company or the board of directors) and the remedy sought. Some of these claims are, for instance, the violation of the right to first refusal, drag or tag-along clauses and lack of approval for selling shares.
Remedies will depend on the type of claim, applicable legal provisions and contractual obligations. However, common remedies include:
- the nullity of certain acts (e.g., a shareholders' meeting, an agreement, a sale of shares, etc.);
- mandatory performance of obligations;
- civil liability; or
- other remedies (e.g., call for a shareholders meeting, delivery of information, etc.).
Directors may be held liable (under criminal or civil law) for acts carried out exceeding the authority conferred upon them. Specific acts that may lead to the liability of directors include:
- negligent or unlawful acts when contracting or assuming obligations on behalf of the company if the act is carried out against the law or the company's by-laws;
- not requesting registration of the company with the federal taxpayers' registry or failing to notify a change of fiscal domicile to the tax authorities;
- in a bankruptcy situation, if wilful acts are carried out to the detriment of the company's financial condition (including by altering, falsifying, not presenting or destroying accounting records of the company); and
- in the event the company is declared null (i.e., a company that carries out illicit acts or has an illicit corporate purpose) due to the customary performance of unlawful acts.
The LGSM sets forth a specific list of obligations and liabilities of directors. Officers are usually granted with powers of attorney and will be liable if they exceed the authority conferred upon them.
In publicly traded companies and companies that choose the publicly traded company management regime under the LMV (SAPIs), the duties of directors include two categories: duty of care and duty of loyalty.
Defences will vary on a case-by-case basis depending on the type of claim, the remedies sought and the particular circumstances of the case. However, for the purposes of this chapter, defences are divided into two main categories: defences of admissibility or formalities, and defences on the merits.
Defences based on admissibility or formalities are those aimed at evidencing that the claimant did not fulfil the legal requirements or formalities to submit a claim:
- lack of legal standing;
- lack of representation;
- not delivering the certificate of deposit of the shares (for opposition claims);
- not submitting the claim within 15 days following the shareholders' meeting (for opposition claims); and
- not meeting the minimum required shares to file a claim (opposition claim); etc.
Defences on the merits depend on the legal and factual grounds adduced by the claimants. Defendants will need to refute such grounds. In shareholder disputes, common defences are that:
- the resolution taken at the shareholders' meeting does not violate the by-laws or the applicable laws;
- the shareholders' meeting is not affected by any of the grounds for its nullification; and
- the other party did not fulfil its own obligations and therefore cannot claim the fulfilment of its counterparty's obligations; etc.
iv Advisers and third parties
Third-party and adviser claims (including lawyers, financial advisers, investment bankers, accountants, brokers, notary publics, tax advisers, among others) are not common in Mexico. However, there are claims that may be filed against advisers specifically related to negligence or malpractice. Most advisers provide waivers and releases in their engagement terms. Issuance of experts' opinions (such as legal opinions) is highly reviewed, negotiated and discussed to limit the exposure of advisers.
v Class and collective actions
Class or collective actions have been permitted in Mexico since 2011. However, thus far, class actions in Mexico have not been used in shareholder disputes or in an M&A environment.
vi Insurance and indemnification
Indemnification in Mexico is limited by applicable statutes. Mexican courts will not normally award punitive, consequential, or indirect damages in commercial disputes. Mexican law follows a 'direct and immediate consequence of the breach' test. This applies to both damages and lost profits. Notwithstanding, as a consequence of a recent judicial precedent dealing with moral damages, a new theory was introduced that effective damage redress could include the need to award damages that are known as 'punitive' in other jurisdictions. However, these types of damages are only applicable to very specific cases and have not become a judicial trend.
Insurance in M&A transactions is not common. However, in recent years, there has been an increase in demand for directors and officers insurance, and representation and warranties insurance is now being offered by certain insurance providers.
The involvement of insurance companies has a huge impact in M&A litigation. If the insurance company pays the policyholder, the insurance company subrogates the policyholder's rights against the counterparty and, thus, the insurance company becomes a party to the dispute. It is different litigating against a company or individual than litigating against an insurance company, which may have more resources and experience in litigation.
Commercial disputes can be freely settled. Settlements may arise from negotiations between the parties or from mediation and can be executed before a claim has been filed or during the litigation proceedings. Settlement agreements are considered res judicata, but subject to being rendered null and void in certain circumstances.
viii Other issues
Interim measures are available in commercial disputes. While the Commercial Code only contains two kinds of interim measures (seizure of assets and travel restraint orders), the Mexican Supreme Court has ruled that the parties may also request interim measures aimed to maintain the status quo of a factual situation. In general terms, the requirements to obtain interim measures are:
- that in a prima facie basis, the petitioner has a good case;
- urgency; and
- the issuance of a guarantee for the potential damages that the interim measures may cause to the other party.
Interim measures may be granted ex parte and, as for normal commercial proceedings, the resolution granting the interim measures is challengeable.
i Common claims and procedure
The most common counterparty claims in M&A transactions generally derive from a breach of a transaction document. In a pre-closing environment this generally relates to a breach of exclusivity, failure to continue ordinary business behaviour prior to closing, failure to obtain regulatory approval or failure to fulfil a condition precedent. In a post-closing environment, the most common disputes generally relate to price adjustments, breach of representations or warranties, failure to comply with a post-closing covenant, or compliance of obligations related to holdbacks or earn-outs.
All components of an M&A deal need to be duly documented to have sufficient evidence to file a claim and succeed in such a claim.
- M&A disputes are settled through an oral commercial trial, unless:
- the law provides for specific alternative proceedings; or
- the dispute is of undetermined amount.
If the dispute is of an undetermined amount, an ordinary commercial trial will take place. Commercial trials are conducted before federal or local courts. Alternatively, if agreed by the parties, arbitration will apply.
Typical time frames for a commercial litigation may range from two to four years.
The available remedies may include the following:
- nullity of all or part of the transaction documents;
- mandatory fulfilment;
- termination; and
- claim for indemnification.
As discussed in Section III, defences change on a case-by-case basis depending on the type of claim, the remedies sought and the particular circumstances of the case. An important aspect to consider in counterparty claims is specific controversies or circumstances where the burden of proof rule is reversed or shifted (i.e., knowledge or similar qualifiers included in the representations in M&A deal).
Arbitration is a common mechanism to settle disputes arising from sophisticated M&A transactions involving Mexico, with the seat of the arbitration either in Mexico or abroad. Arbitration agreements and arbitration awards are protected and enforceable in Mexico, regardless of whether the seat of the arbitration is in Mexico or elsewhere. Additionally, Mexican courts will assist international and domestic arbitration proceedings.
Nevertheless, to include an arbitration clause to settle shareholders' or M&A disputes, additional considerations are needed, which are not necessarily present in other traditional transactions. Arbitration contained in the by-laws of a company provides some challenges:
- Are new shareholders bound by an arbitration agreement adopted prior to their admission?
- Are shareholders that voted against the inclusion of an arbitration agreement bound by it?
- Access to certain reliefs might not be available.
Arbitration clauses included in shareholders' agreements or in M&A transactions should seek uniformity in all relevant documents, otherwise there are important risks, like:
- having parallel proceedings resolving the same issues;
- impossibility of calling third parties;
- impossibility of consolidating proceedings; and
- unenforceability of the arbitration clause; etc.
v Other issues
M&A transactions in Mexico are tailor-made and judicial precedents and market standards are vague. Thus, structuring and implementing an M&A deal will depend on the parties involved and how sophisticated the deal is. It is very common to encounter a sophisticated party dealing with an unsophisticated counterparty. This creates an inefficient deal and increases the risk of litigation.
As further discussed below, deciding on the applicable laws, venues and jurisdiction is a sensitive subject.
A fairly common issue during M&A negotiation is using the 'market standards' argument. Market standards in Mexico are not clear because public precedents are few far between and, thus, standards are set by the advisers.
i Substantive law and jurisdiction
Mexican Company Law typically follows the rules regarding jurisdiction and applicable substantive law as described below.
Substantive law (choice of law)
Mexican laws apply to:
- all persons in the Mexican territory;
- acts occurring within the Mexican territory or jurisdiction; and
- acts that are subject to Mexican laws (either by mandatory provision or agreement).
The determination of applicable law shall be made in accordance with the following rules:
- the legal act is validly created in Mexico or a foreign country according to its law will be recognised;
- the capacity and status of any individual is governed by the law of their domicile;
- real estate, as well as contracts for the lease and temporary use of them, are governed by the law of its location, even if its owners are foreigners;
- the form of legal act is governed by the law of the place where it is performed; and
- the legal effects of acts and contracts shall be governed by the law of the place where they are to be performed, unless the parties have validly designated the applicability of another law.
Foreign law can be applied by Mexican courts as would be done by the corresponding judge. The Mexican authorities may request all information about the text, validity, meaning and legal scope of the foreign law. If different aspects of the same legal relationship are regulated by different laws, these should be applied harmoniously (to the extent that the court, in the resolution of the dispute, should seek to protect the rights of and avoid causing harm to the parties).
In the context of a commercial dispute, and more precisely in M&A disputes, any party alleging the applicability of a foreign law will have the burden of proof to provide evidence towards its existence, enforceability and scope of application in the specific case.
A party's autonomy is the general principle following commercial law. However, the general restrictions are dictated by public policy, prohibitive laws and third-party rights.
The place of domicile of a Mexican corporation is a key element to determine the appropriate forum in connection with a dispute related to its incorporation, existence and its corporate life. For other types of actions, the general principles of conflict of norms, the features of parties involved and the nature of the potential subject matter of the dispute will need to be taken into consideration.
In general terms, the current legal framework in respect to jurisdiction for personal and private claims follows objective criteria, based on features or functional connections with the claim's nature: subject matter, territory, amount in dispute and instance. Recent court precedents have determined that parties may choose the jurisdiction they submit to as long as there is a relevant connection between the parties' 'domicile' or the place where they should perform their obligations or where the object in dispute is located and the jurisdiction of choice.
Furthermore, a court will be deemed to have jurisdiction according to the following rules:
- based on the place where the defendant has designated to be required judicially to pay his or her duties;
- the place where the obligation is meant to be performed;
- the location of the assets (in rem type of actions over real estate assets or lease agreements);
- the domicile of the defendant; and
- insolvency and bankruptcy proceedings would normally follow the rule of the location of the debtor.
This overview reflects the most common aspects pertaining to issues of jurisdiction, provided that in specific types of claims (based on the parties involved, the nature of the dispute and potential exclusive forum jurisdiction – i.e., federal versus state attributions or jurisdictional exclusive federal reserved items) parties will be prevented to agree on jurisdiction, where such matters would be regulated by a binding statutory provision granting jurisdiction to a specific type of tribunal or administrative body, or a particular procedure and venue where the case could be heard.
ii Service of process
Service of process in Mexico is protected on a constitutional basis as part of due process of law principles. Such an essential formality, from a procedural standpoint, entails a fundamental right that secondary legislation still regulates in a very strict and scrutinised fashion.
In general terms, service of process of a company should be conducted in the company's domicile and dealt personally with a legal representative of such entity where the court official has to deliver proper notice of the lawsuit, the documentary evidence and each and every resolution issued by the court prior to such service. All relevant documents should be properly sealed and numbered by the court.
The court official has to observe strict formalities when serving the notification and gather supporting evidence of each relevant aspect of such service. To contravene those formalities could lead to the nullity of the service of process and, consequently, process derived therefrom.
iii Cross-border awareness and judicial assistance
In the context of cross-border disputes, Mexico is a party to the Hague Convention on the Service Abroad of Judicial and Extra Judicial Documents in Civil and Commercial Matters and to the Inter-American Convention on Letters Rogatory, drafted to simplify and standardise the international service process between signatory parties. Requests for service under these treaties should be transmitted to the Secretary of Foreign Affairs, who acts as the Mexican Central Authority for these matters.
Moreover, in the framework of international procedural cooperation, certain guidelines must be observed regarding the recognition and enforcement of foreign judgments, awards, evidence gathering and other foreign decisions and notices. Normal restrictions in judicial assistance would be related to due process of law, sovereignty reserves, reciprocity and public order.
Year in review
i Prominent cases
In July 2019, Corporativo Coral and Mr Miguel Alemán Magnani (Grupo Alemán) agreed with Televisa, the Mexican media conglomerate, on the acquisition of 50 per cent of the capital stock of Radiopolis, a company involved primarily in the operation of radio stations throughout Mexico, for the amount of 1,248 million pesos.
The purchase price was to be paid in several instalments. Allegedly, Grupo Alemán failed to make an initial payment of 624 million pesos, that was due in August 2019 once the authorisation from the Federal Telecommunications Institute (IFT), the Mexican telecoms regulator, was granted. Televisa is seeking full payment of the purchase price and other ancillary amounts.2
The request for authorisation for the merger between Uber, the on-demand transportation company, and Cornershop, an on-demand grocery delivery service that operates in the Latin American market, was originally filed before the COFECE. However, the IFT sustained it was the competent authority to analyse the request owing to the fact that both companies render their services through technological applications or 'apps'.
This resulted in a dispute regarding jurisdiction. After analysing arguments from both agencies, the Specialised Antitrust Courts determined that COFECE was the competent authority to examine the request for the merger.
The court's decision was based on the argument that, although Uber and Cornershop render their services through apps, the nature of their services is not related to telecommunications and the companies only use their apps as a means to offer and render their services.3
Without a doubt, this is a landmark decision resolving the regulators' competence regarding companies involved in e-commerce, which is a sector that has grown tremendously in Mexico.
Another relevant matter is the merger between Disney and 21st Century Fox. This merger had effects in several jurisdictions, including Mexico.
According to a number of media outlets, Televisa obtained a precautionary measure from a federal judge to prevent the closing of the acquisition of Fox by Disney. Televisa's main argument consisted of the alleged lack of analysis by the IFT of Televisa's arguments to oppose to the merger. Such arguments were presumably raised by Televisa in an antitrust complaint filed before the IFT. The federal judge ordered the IFT to analyse Televisa's arguments.4
Tax advisers' responsibilities
On 19 December 2019, a new section titled 'Disclosure of Reportable Schemes' was incorporated into the Mexican Tax Code (CFF). Under this new regime, tax advisers are obliged to disclose generalised and personalised disclosable schemes to the Tax Administration Service (SAT).
A 'tax adviser' is understood to be any natural person or legal entity who, in the ordinary course of his or her activity, performs tax advisory activities, and is responsible for or is involved in the design, commercialisation, organisation, implementation or administration of the entire reportable scheme or makes the entire reportable scheme available for its implementation by a third party. Under the CFF a tax adviser may be a resident of Mexico or a party residing abroad that has a permanent establishment in the country, as long as their activities in Mexico are the types of activities conducted by a tax advisor.
A 'reportable scheme' is considered to be any scheme that generates or may generate, directly or indirectly, the obtaining of a tax benefit in Mexico and that has any of the characteristics set forth in Article 199 of the CFF, which includes, among other things, that the scheme prevents foreign authorities from exchanging fiscal or financial information with the Mexican tax authorities or consists of one or more legal acts that allow tax losses pending reduction of tax profits to be transmitted to persons other than those who generated them.
This is an unprecedented legal reform that targets tax advisers, whom, under the CFF, are now subject to penalties that could go up to 20 million pesos and criminal liability if they fail to report or file an incomplete report of a reportable scheme. In almost – if not all – M&A transactions, a tax adviser is involved.
Material adverse effect and material adverse change provisions
In the context of the covid-19 pandemic, M&A parties have material adverse changes (MACs) of material adverse effect (MAE) at the centre of their negotiations or discussions. Usually, agreements for the sale of a company or a company's assets include provisions regarding MAC or MAE. Under such provisions, the party affected by such changes may be relieved of the duty of fulfilling its contractual pre-closing or post-closing obligations, or may have the right to terminate the contract.
Nevertheless, given the severe consequences of these types of provisions, usually the threshold for triggering them are quite complicated to meet. As a consequence, Mexico – as well as every other country affected by covid-19 – is experiencing a rise in litigation matters involving the interpretation of MAE and MAC provisions, which will ultimately determine if a party has committed a breach of contract.
Distressed business acquisitions
Another trend we are beginning to see in Mexico is the acquisition of distressed businesses. Such acquisitions are made before any legal proceeding is commenced, but in some cases such acquisitions are made during a bankruptcy proceeding. These types of transactions, even those made when no bankruptcy filing has been made, have a high potential for litigation.
Distressed M&A usually increases the risk of litigation owing to the fact that third parties, such as creditors or any other third party with a legal interest, usually oppose the transaction and may seek to prevent or reverse the transaction. Further, the seller is usually in a dire situation. If legal proceedings have begun, there may be limitations as to what type of transactions the target company may enter into. Such limitations, in a civil law country as Mexico, often come from the law, but may sometimes be ordered by the bankruptcy court.
Outlook and conclusion
Mexico is an attractive jurisdiction for investors and investment because the modernisation of its legal framework, the improving network of its international agreements and its continuous adaptation to international standards provide a reliable and foreseeable landscape for foreign investment.
However, paving the transition to a major economy appears to be a major challenge, as the worldwide crisis and pandemic has delayed the development that countries with similar characteristics have experienced. Thus, strengthening institutions and having a strong and independent judiciary, together with providing a safer environment for business, would certainly help to focus the business community's interest in Mexico for inbound investment. During 2019, the new Mexican administration has not been able to secure certainty for investors to promote further foreign investment in the country. Thus, as is generally the case in economic downturns, litigation and disputes will increase.
The internal market (and foreign investment in the internal market) could be significantly fuelled by the successful implementation of anti-corruption laws and creating economic and political certainty to promote investment.
1 Alejandro García-González and Luis Ernesto Peón are partners and José Antonio Noguera and Carlos Alvarado are senior associates at Hogan Lovells.