The Mergers & Acquisitions Review: Mexico
Overview of M&A activity
Mexico has improved its commercial law legal system in recent years through deregulation and execution of bilateral and multilateral agreements on trade and investment, in an effort to become a suitable, stable, safe and viable venue in which to conduct business and invest. The 2020 effectiveness of the new free trade agreement with the United States and Canada (USMCA) confirms such commitment.
Over the past several years, Mexico has significantly modified its legal framework. The pre-2020 administrations sought to liberalise and open the oil and gas and electricity sectors, while at the same time eliminating foreign investment restrictions in key areas (e.g., financial and telecoms), revamping antitrust and telecoms regulations, and modernising financial and insolvency laws to ease loan collection and enhance consumer protection within the financial sector. These amendments were by-and-large considered to be 'structural reforms', a term adopted by the former Mexican administration in its campaign to promote Mexico as an ideal place for foreign investment. However, it is indeed a reality that the current Mexican administration is seeking to revert certain reforms as part of its political agenda since winning the federal elections in July 2018 and has indeed made controversial decisions in its attempt to do so.
Despite certain advances, adapting to new market trends and innovation in the Mexican M&A culture is still some way off. These trends include departing from certain older rigid statutes and traditional legal practices, and revamping our judicial system to allow more efficient, speedier and reasonable judgments. In this regard, Mexico must transition to a true rule of law system that provides equal access to justice for all players and ensures effective protection and redress.
The M&A market in Mexico saw an uptick resulting from updated legislation, the country's location neighbouring the United States (the world's largest consumer market) and several other benefits that are briefly described below. However, this has been followed by a downturn in the Mexican economy and covid-19, which may increase M&A litigation volume. Distressed M&A have become a trend in the Mexican M&A market and will continue to be a great alternative for players with sufficient cash and liquidity looking for attractively priced target companies.
General introduction to the legal framework for M&A
The main laws regulating the M&A market touch upon all areas of business law, from company incorporation and transfer of ownership including securities, antitrust and competition, general business and business transactions, to data privacy, tax law and the protection of intellectual property.
The Mexican economy is significantly open to foreign investments, has no restrictions for the outbound transfer of currencies, has a strategic geographical location and has the largest number of free trade agreements of any country in the world,2 which places Mexico in a privileged position. Among the free trade agreements entered into by Mexico, three represent access to the three largest free trade zones in the world:
- the USMCA between Mexico, the United States and Canada;
- the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (TPP) between Mexico, Canada and several Pacific countries such as Australia and Japan; and
- the Economic Partnership, Political Cooperation and Cooperation Agreement (known as the Global Agreement) between Mexico and the European Union (currently pending ratification of its latest modernisation).
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 transition to more oral-based proceedings in commercial matters is now formally in place). 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 effects of covid-19, a necessary transition to online dispute resolution mechanisms.
The main sources of law for M&A transactions in Mexico, in order of precedence, are the Mexican Constitution; international treaties (which are granted the same hierarchy as the constitution when it comes to human rights); statutes, administrative bands and regulations; and contracts and rulings. The interpretation of the law is done according to the express text of the law, its interpretation by judicial precedents and the 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 corporations 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 Constitution;
- the General Law of Commercial Companies;
- the Securities Market Law;
- the General Law of Negotiable Instruments and Credit Transactions;
- the Commercial Code;
- the Federal Civil Code;
- the Federal Commercial Insolvency Law;
- the Foreign Investment Law;
- the Federal Law of Economic Competition (LFCE); and
- the Federal Law to Prevent and identify Transactions with Illegal Resources.
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 Economic Competition Federal Commission (COFECE) and, in public M&A deals, the Banking and Securities National Commission. Other regulators may be involved depending on the industry sector (telecoms, mining, banking, etc.).
Developments in corporate and takeover law and their impact
In general, Mexican laws and regulations regulating M&A activity in Mexico have not had any substantial amendments or reforms in the past couple of years, apart from minor amendments regulating e-signatures for certain documents.
In the context of the covid-19 pandemic and global financial instability, M&A participants consider material adverse changes or material adverse effects to be central to their negotiations or discussions. Usually, agreements for the sale of a company or a company's assets include provisions regarding material adverse changes or material adverse effects. Under such provisions, the party affected by such changes may be relieved from fulfilling its contractual pre-closing or post-closing obligations, or may have the right to terminate the contract. It has become a major trend for all M&A transaction documents to further expand on material adverse effect (MAE) and material adverse change (MAC) definitions to cover contingencies related to the covid-19 pandemic and global financial instability.
Nevertheless, given the severe consequences of these types of provisions, usually the threshold for triggering them is quite high. As a consequence, Mexico – as well as every other country affected by covid-19 and financial instability – 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.
Another trend we are beginning to see in Mexico is the acquisition or takeover 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.
A distressed M&A usually increases the risk of litigation because usually third parties, such as creditors or any other third party with a legal standing, oppose the transaction and may seek to prevent or reverse a 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 such as Mexico, often come from the law, but may sometimes be ordered by a bankruptcy court.
Foreign involvement in M&A transactions
Due to the geographic location of Mexico and its very close business relationship with its northern neighbours, the United States and Canada have been clearly the main business partners for Mexico. However, as a result of political developments in recent years, Mexico has further strengthened its business relationship with European and Asian allies.
In the recent past it was very common to see US or Canadian investors involved in sophisticated M&A transactions. This has not been the case in recent years. While US and Canadian investors remain very active, there has been an increase in investment and M&A activity from European and Asian investors, including considerable investments from European and Asian automakers, and the recent incursion into Latin America by multi-billion US$ investment funds from China such as the prolific Softbank group of funds.
Mexico is generally considered to be a country open to receiving foreign investments, and market participants may expect few to no restrictions when doing business in the country. Foreign investors should be wary, however, of Mexico's changing political landscape, which is basically driven by the policy of the at-the-time current government, an unpredictable and inefficient bureaucracy, and possible fluctuations in foreign currency exchange rates over short periods of time. In that context, investor trust in Mexico's stability has been dealt a big blow in the past two years after the arbitrary cancellation of the new Mexico City airport (NAIM), changes in the country's energy sector policies, and irregular cancellations of other investment and infrastructure projects. That blow to investment confidence has been coupled with erratic government decision-making. On the plus side, the passing and coming into effect of the USMCA does create a strong foundation for a continued investment and trade relationship in all of North America, which is a key element for long-term planning and redress in cases of unfair or discriminatory treatment.
Significant transactions, key trends and hot industries
The technology sector has been one of the leading industries driving the M&A market in Mexico. This is largely the result of a combination of two major and recent elements:
- new laws and regulations have been passed and enacted, such as the Fintech Law and its regulations, which have helped pave the way for new investments in technology companies (particularly financial technology and ancillary industries), as well as providing legal clarity and certainty to foreign market participants; and
- important investments have been made by large multinational entities in Mexico seeking to expand their operations and enter an increasingly sophisticated market and, in some instances, initiate a foothold and base of operations to expand into the rest of Latin America (generally speaking, Spanish-speaking countries).
The Fintech Law governs, for the first time, transactions performed using virtual assets (cryptocurrencies). Financial technology institutions may only operate with virtual assets authorised by the Mexican Central Bank under the terms and conditions it eventually determines under the enabling regulations. Banking institutions may carry out transactions with virtual assets determined by Mexican Central Bank through enabling regulations with the prior authorisation of said regulator. In addition, the Fintech Law also allows the regulatory sandbox concept whereby persons offer financial services using technological tools that are not established in an existing mechanism, subject to certain restrictions. Further, the Fintech Law addresses application programming interfaces and automated investment advisers, among other cutting-edge technologies in the financial sector.
In recent years, Mexico has been host to companies such as Amazon and MercadoLibre (to name only two), both of which have significantly increased their operations in Mexico mainly through a mix of substantial capital investments, the acquisition and expansion of infrastructure, and an array of joint venture and similar strategies intended to increase their presence and local market share.
While there has been a significant amount of private equity, venture capital and smaller-scale M&A technology transactions (particularly involving startups and fintech companies), large-scale transactions in the M&A technology sector remained few and far between during 2019, 2020 and also largely in 2021. The few transactions involving the technology sector have mainly been the result of entities choosing to consolidate their presence while slowing down their M&A activity as a natural result of corporate actions adopted from foreign parent companies, which actions and decision-making have tended to be stagnant and risk-averse in the past few years, for the reasons already explained above.
Another main area of M&A activity and commercial transactions in general has been the automotive industry. Due to the large volume of investment that Mexico has received in recent years from original equipment manufacturers, there has been considerable interest in consolidating suppliers and creating efficiencies in the automotive industry. Mexico is a key player in the industry, as it is the sixth-largest manufacturer and the fourth-largest exporter worldwide.
Finally, M&A activity in the real estate industry has grown exponentially in the past decade, in particular through local real estate investment trusts and other investment vehicles that are now quoted in the securities market, thus allowing an increase in the value of real estate portfolios through the acquisition of multiple key real estate assets.
Financing of M&A: main sources and developments
Mexican laws are not restrictive regarding financing schemes related to M&A transactions. Thus, parties are able to finance or secure transactions using the target's assets, their own assets or third-party funds. International and local financial institutions, private equity funds, fintech entities and other financial players have all been active in the Mexican M&A sector, and are constantly increasing their investment appetite considering the potential in the local M&A landscape.
As discussed above, in the context of the covid-19 pandemic and global financial instability, lenders in sophisticated M&A transactions will usually seek foreign applicable laws and jurisdictions, such as New York, to secure the enforcement of MAC or MAE clauses. In addition, obtaining a security interest over high-value collaterals is key in protecting lenders' interests. However, a fine balance needs to be sought in obtaining good collaterals and not hindering debtors' financial capability to operate a newly acquired business.
Financial arrangements may generally include standard banking credit agreements, financial statements, promissory notes, guarantees, collateral agreements, trusts and other documents as required on a case-by-case basis. Financing depends on the specific valuation of the relevant transaction and market conditions.
In 2019, Mexico amended and enacted legislation related to employment laws that: (1) further protect employee rights and further forbid employers from harming employees' rights; (2) strengthen employees' rights to become part of or to separate from a union; and (3) allowed employees to actually represent, and be selected and supported, by the workforce.
These amendments were initially triggered by the ratification of the TPP and the International Labor Organization's Right to Organise and Collective Bargaining Convention No. 98. However, in parallel, Mexico was in the process of negotiating the new USMCA that would replace the North America Free Trade Agreement.
The USMCA includes, in its Article 23 and Annex 23-A, the obligations of Mexico to: (1) revamp the labour and employment legal framework; (2) ensure the rights of freedom of association and collective bargaining; and (3) implement a new system of labour justice independent of the executive branch of government.
The amendments to the Federal Labour Law are mainly focused on achieving the following:
- freedom of association and collective bargaining;
- the creation of labour courts to replace the current conciliation and arbitration boards;
- other amendments in line with the political agenda of the current administration;
- diversity and inclusion;
- avoiding discriminatory practices, mobbing and sexual harassment;
- gender equality; and
- maternity protections.
Outsourcing and subcontracting regimes continue to be important issues to consider in Mexico. These kinds of schemes must be carefully analysed and reviewed to determine and ensure compliance with the Federal Labour Law.
Mexico undertook certain relevant tax reforms in 2019 and 2020. These include important tax changes that affect international companies that have operations in Mexico. The main intent of the reforms has been to strengthen compliance with the existing tax structure and to more strictly regulate the challenging base erosion profit shifting requirements. Financing structures, tax planning and cross-border transactions should be a main focus for M&A deals to identify, mitigate and minimise risks related to non-deductible payments or additional compliance obligations.
Relevant to M&A advisers are the items incorporated into the Mexican Tax Code (CFF) under the title 'Disclosure of Reportable Schemes'. Under this new regime, tax advisers are obliged to disclose generalised and personalised disclosable schemes to the Tax Administration Service.
A tax adviser is understood to be any natural person or legal entity that, in the ordinary course of his, her or its activity performs tax advisory activities, and is responsible for or is involved in the design, commercialisation, organisation, implementation or administration of, an entire reportable scheme, or makes that 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 his, her or its activities in Mexico are those conducted by a tax adviser.
A reportable scheme is considered to be any 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 include, 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 a reduction of tax profits to be transmitted to persons other than those that generated them.
This is an unprecedented legal reform that targets tax advisers who, under the CFF, are now subject to penalties that could reach 20 million Mexican 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.
The current competition statute, the LFCE, was enacted on 23 May 2014. The 2013 constitutional amendment that underpinned said statute related to economic competition, also created an investigating authority to separate the bodies involved in the investigation process from the bodies responsible for the decision-making process. This independent body is entrusted with investigating allegedly anticompetitive behaviour from the administrative and not the criminal standpoint, as criminal investigations are reserved for the Attorney General Prosecution Office.
The LFCE contains harsh penalties for antitrust violations. Likewise, it provides some tools for the enforcers to control prices for goods that are considered 'necessary for the national economy' or that are goods of 'popular consumption'. The LFCE also empowers the enforcers to issue provisional remedies, determine essential facilities, order divestiture of undertakings, and remove or regulate barriers to competition.
The LFCE is a federal law, and there are no state competition laws, no treble damages and no trials by jury. The primary objective of the LFCE is to promote economic efficiency and protect the competition process and free market participation (concurrently with the Constitution, which seeks to protect consumers as well). To this end, the LFCE directs its attention to the behaviour of economic agents and to sanctioning monopolistic practices and other acts that restrain competition. The LFCE also outlines a preventive approach for dealing with concentrations (i.e., mergers and acquisitions or acquisitions of control) that could lead to the creation of or an increase in market power.
The LFCE provides that any M&A transaction that falls within the wide definition of a concentration requires notification to and clearance by COFECE (or the Telecommunications Federal Institute (IFT) in the telecom and technology industries) prior to concluding the relevant transaction, if specific thresholds are met in connection with the value of the transaction, the accumulation of assets, the accumulation of capital stock and the value of assets of the entities involved.
Enforcement by COFECE and IFT has increased in recent years, and the approval of M&A transactions has become a sophisticated and complicated legal area. Transactions subject to prior clearance cannot close absent a specific clearance, with significant sanctions and divestiture orders being applied otherwise.
A recent relevant case was the request for authorisation for a merger between Uber, the on-demand transportation company, and Cornershop, an on-demand grocery delivery service that operates in the Latin American market, that was originally filed before COFECE. However, the IFT sustained it was the competent authority to analyse the request because both companies render their services through technological applications (apps).
This resulted in a dispute as to 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. Prior to this situation, the COFECE effectively stopped the acquisition of Cornershop by Walmex, alleging an undue concentration of power in certain relevant sectors.
Without doubt, these are landmark decisions resolving the regulators' competence regarding companies involved in e-commerce, which is a sector that has grown tremendously in Mexico.
Mexico is an attractive jurisdiction for investors and investment because of the modernisation of its legal framework, the growing network of its international agreements and its continuous adaptation to international standards. All these elements combined provide a generally reliable and attractive 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. Although the current Mexican administration has been unable to secure certainty for investors to promote further foreign investment in the country, it is also true that the recent midterm elections generated a more divided government that, ironically, seems to be better suited to promote investment or, at least, to stop damaging decisions from being executed unobjected. The government will need to reconcile its internal decisions with the overall stability and promotion standards that are formally recognised in instruments like the USMCA.
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. The jury is out on whether Mexico is able to consolidate its status as a safe haven for important investments that may benefit from its significant domestic market and access to important overseas markets given its large network of free trade and investment agreements.
1 Juan Francisco Torres Landa Ruffo is a partner and Pablo Corcuera Bain is a senior associate at Hogan Lovells.