Transaction structures and sale processCommon structures
What sale structures are commonly used for distressed M&A transactions in your jurisdiction? What are the pros and cons of each, and what procedures and legal requirements apply?
A distressed M&A transaction may be implemented in the context of a judicial reorganisation proceeding or outside a formal insolvency proceeding (in this case, basically whenever a company nears insolvency).
In general, a transaction performed outside an insolvency proceeding allows the parties to negotiate and execute the transaction with more freedom and flexibility considering that it does not require prior approvals by creditors or the bankruptcy court. However, an out-of-court M&A transaction does not entirely protect the buyer from clawback and succession risks, which tend to be higher in a distressed M&A deal.
Under a reorganisation proceeding, both in a direct sale or in an isolated productive unit (UPI) sale, M&A transactions may be implemented as a sale of shares or assets of the debtor.
Despite the legal protection against succession and clawback risks, the sale of a UPI may take longer than a direct sale. The sale of a UPI must be provided for in the reorganisation plan approved by the creditors and confirmed by the bankruptcy court. The Brazilian Bankruptcy Law also requires conducting a competitive process for the sale of a UPI to grant transparency and maximise the value of the asset being sold, among other reasons. The Brazilian Bankruptcy Law also provides for an alternative competitive process organised and conducted by a specialised agent and such process shall be detailed in the reorganisation plan.
Another alternative structure for M&A transactions under a reorganisation plan that is becoming increasingly usual is the debt-to-equity swap, in particular in reorganisations with the relevant participation of international creditors and investment funds. In view of the recent amendments to the Brazilian Bankruptcy Law, creditors were granted greater comfort to approve a debt-to-equity swap structure by expressly providing that creditors shall not be held liable or successors of the debtor in the case of a debt-to-equity swap.
In Brazil, only the debtor is able to file a reorganisation plan, so the debtor remains in control of the process in the majority of cases. The recent amendments to the Brazilian Bankruptcy Law have provided for the possibility (still untested) of creditors filing alternative plans, but only if the debtor does not file a plan within 360 days (counted from the judicial recovery filing date) or if the plan proposed by the debtor is rejected by the general meeting of creditors. Although this possibility may change the scenario – still unclear to what extent – to date, all distress acquisitions have been necessarily proposed by the debtor (or its management) or negotiated and contracted with it.Packaging and transferring assets
How are assets commonly packaged and transferred in a distressed M&A transaction in your jurisdiction? What procedural, documentary and other requirements apply?
Assets are commonly packaged and transferred in a distressed M&A transaction by means of the transfer of shares of subsidiaries of the seller to the buyer, or by the drop-down of assets to a special purpose vehicle (SPV) and the transfer of 100 per cent of the shares of such SPV to the buyer. While the former is most often used in distressed M&A transactions outside a reorganisation proceeding, the latter is especially used in the context of a UPI sale to enable the transfer of certain assets of the debtor or even a business unit free and clear from the liens and liabilities of the debtor.
The sale of shares of a subsidiary is usually preceded by a full due diligence of the target and negotiation and execution of a sale and purchase agreement (SPA). If the seller is under judicial reorganisation, the transaction may be submitted to the bankruptcy court’s approval or, alternatively, be provided for in the reorganisation plan approved by the creditors and confirmed by the bankruptcy court. Following the recent amendment of the Brazilian Bankruptcy Law in December 2020, the sale of non-current assets of the debtor may also be approved by a creditors’ meeting specially called for this purpose. The shares of a subsidiary of the debtor company may also be sold as a UPI (ie, free and clear from any liens and liabilities of the debtor) under a judicial reorganisation proceeding.
The drop-down structure requires the creation of an SPV and the execution of additional corporate acts to authorise the capital increase of the SPV and the contribution of the assets to be transferred to the SPV. Once the drop-down is completed, the shares of the SPV are transferred to the buyer by means of the negotiation and execution of a SPA. Since the drop-down structure is commonly used in the context of the acquisition of a UPI (ie, free and clear from any liens and liabilities of the debtor), the scope of due diligence is usually limited to contingencies and liabilities inherent in the acquired assets (propter rem nature obligations).Transfer of liabilities
What legal requirements and practical considerations should be borne in mind regarding the acceptance and transfer of any liabilities attached to the distressed company or assets?
Successor liability rules apply in the case of transfer of a business as a going concern (which may be effected regardless through the transfer of the shares of a subsidiary of the seller or through the acquisition of one or more business units of the seller or any other structure eventually adopted).
As a general rule, in the case of transfer of individual assets or properties, the buyer should not be considered a successor of the seller and therefore should not be held liable for the liabilities of the seller. However, any debt or liability inherent to the assets or properties acquired that has a propter rem nature is attached to the transferred asset or property, and the buyer shall be responsible for its payment (such as environmental damages and property taxes).
As per the transfer of a business unit (or a commercial establishment), as a general rule, the buyer is liable for the debts existing prior to the transfer. However, there are some specific rules applicable to different natures of debt (such as civil and commercial debts, labour, tax, environmental and anti-corruption debts), which are exemplified below.
- Civil and commercial debts. Article 1,146 of the Brazilian Civil Code establishes that the buyer is liable for the payment of the debts existing prior to the transfer of a business unit, provided that such debts are fully reported in the financial statements of the seller. The seller remains jointly and severally liable for such debts for a period of one year following the transfer or, if the claim is not yet due by the date of the transfer, following the due date.
- Tax debts. Article 133 of the Brazilian Tax Code provides that the buyer of a business unit that continues to engage in the same business as the seller is liable for the taxes related to the acquired business unit, due and payable up to and until the date of transfer. The buyer’s liability is full if the seller ceases to engage in business following the transfer, and subsidiary if the seller continues to engage in business or initiate a new business within six months following the transfer, in the same or in a different field of activity.
- Labour debts. Pursuant to articles 10 and 448 of the Brazilian Consolidated Labour Laws, any change in the ownership or corporate structure of the company shall not affect the employees’ rights. The buyer of a business unit, as the successor of the company, is responsible for the payment of all labour obligations, including those assumed before the acquisition.
- Environmental debts. Environmental debts, damages and obligations inherent in the business unit are considered propter rem obligations and the buyer is fully responsible for their payment.
- Anti-corruption debts. Pursuant to article 4 of the Brazilian Anti-Corruption Law, the liability of the company for debts arising from the Brazilian Anti-Corruption Law remains unchanged in case of a change in the corporate structure, transformation, acquisition, merger or spin-off of the company. In the case of mergers and acquisitions, the first paragraph of article 4 states that the liability of the successor is limited to the payment of penalties and the compensation for damages caused by the corrupt acts. Other sanctions provided for in the Brazilian Anti-Corruption Law (such as the declaration of lack of good standing to execute contracts with the public administration) related to acts practised before the transaction are not applicable in these cases, except in the case of fraud or simulation.
Despite the successor liability rules mentioned above, in the context of a judicial reorganisation it is possible to acquire a business unit free and clear from liabilities of the debtor (including labour, tax, environmental and anti-corruption liabilities) if the acquisition is carried out by means of a UPI, pursuant to article 60 of the Brazilian Bankruptcy Law, or upon an auction or organised competitive process according to the plan pursuant to article 66, 3rd paragraph, of such law.Consent and involvement of third parties
What third-party consents are required before completion of a distressed M&A transaction? What are the potential consequences of failure to obtain these consents? In what other ways are third parties commonly involved in the transaction?
The completion of a distressed M&A transaction outside an insolvency proceeding requires the same third-party consents required as in non-distressed M&A transactions, including corporate authorisations, general third-party waivers to avoid acceleration of existing debt or termination of operational agreements and, in the case of M&A transactions performed in regulated markets, the approval of the relevant public authorities. Also, the transaction may be subject to antitrust controls.
Distressed M&A transactions performed in the context of a judicial reorganisation proceeding, in addition to the requirements mentioned above and if the transaction involves the transfer of non-current assets of the debtor (which usually is the case in M&A transactions) must be submitted to the bankruptcy court’s approval or, alternatively, be provided for in the reorganisation plan approved by the creditors and confirmed by the bankruptcy court. Following the amendment to the Brazilian Bankruptcy Law in December 2020, the sale of non-current assets of the debtor may also be approved by a creditors’ meeting specially called for this purpose.
The completion of a distressed M&A transaction as an isolated productive unit (ie, carried out free and clear from any liens and liabilities of the debtor company), in addition to the requirements mentioned above, must also observe the following: first, the sale must be provided for in the reorganisation plan approved by the creditors and confirmed by the bankruptcy court; second, the Brazilian Bankruptcy Law requires the conduction of a competitive process for the sale of a UPI. Third, the buyer shall not be related to the debtor or identified as an agent of the debtor for the purpose of defrauding succession.Time frame
How do the time frames and timelines for the various transaction structures differ? Can these be expedited in any way?
Regardless of the deal structure, distressed M&A transactions involve the conduction of due diligence of the target company or assets, the negotiation and execution of an SPA and submission of the transaction by antitrust authorities (if applicable) and other relevant public authorities, depending on the industry. The timetable for these acts does not differ from a traditional M&A transaction.
For transactions carried out in judicial reorganisation proceedings, the timing for conclusion of the transaction also depends on meeting the requirements provided by the Brazilian Bankruptcy Law. Pursuant to such law, the transfer of non-current assets of the debtor (which usually is the case in M&A transactions) must be submitted to the bankruptcy court’s approval or, alternatively, be provided for in the reorganisation plan approved by the creditors and confirmed by the bankruptcy court. The timing of the approval by the bankruptcy court may vary significantly. It may take 30 to 90 days from the date on which the debtor files a petition requesting the court’s approval; however, according to the complexity of the transaction and any legal disputes arising thereto, this time frame could be extended. An in-court distressed M&A transaction usually provides as a closing condition the non-existence of appeals against the court order. If appeals are filed, a definitive decision on the matter by a Court of Appeals may take six to 12 months.
The implementation of a distressed M&A transaction under a reorganisation plan requires the approval of the plan by the general meeting of creditors and then the confirmation of the plan by the bankruptcy court. Pursuant to the Brazilian Bankruptcy Law, the debtor has 60 days following the commencement order, and the meeting of creditors to vote on the reorganisation plan shall be held within 150 days from the commencement order. Despite the legal requirements, it is common that the meeting of creditors is repeatedly suspended and postponed to allow further negotiations among the debtor and creditors. If the sale is conducted by means of a UPI, free and clear from any liens and liabilities of the debtor, the sale must be provided for in the reorganisation plan and preceded by a competitive process, such as a public auction or a private competitive process organised by a professional agent. Public auction processes have typically taken 30 to 90 days from the court confirmation order.Tax treatment
What tax liabilities and related considerations arise in relation to the various structures for distressed M&A transactions in your jurisdiction?
In essence, two main considerations usually arise in relation to distressed M&A transactions in Brazil under a tax perspective:
- tax treatment applicable to the taxable capital gain derived by the seller, if any; and
- tax succession rules affecting the target company and target assets and, therefore, the buyer.
As to item (1), it is worth mentioning that groups under distress usually register significant amounts of net operating losses (NOLs). As a general rule, NOLs can be carried forward indefinitely but can only be used to offset up to 30 per cent of the taxable profits of the period. In the case of a company disposing assets (including equity stake in other companies), only 30 per cent of the taxable gain can be offset against NOLs and the corporate income taxes due on the remaining amount may require a cash disbursement, which is particularly challenging in cases of financial distress.
The changes recently implemented to the Brazilian Bankruptcy Law have addressed this issue of companies disposing assets and rights within the context of judicial recovery or bankruptcy, as authorised by the reorganisation plan or by the court: these companies are authorised to fully offset the capital gains against the NOLs and the 30 per cent cap does not apply. This is a positive legislative development towards the recovery of companies in financial distress, although the scope of the legal provision is limited to judicial sales implemented by companies under judicial reorganisation or bankruptcy.
As to item (2), it is also true that companies under financial distress are parties to several administrative and judicial proceedings related to tax liabilities, apart from the non-materialised tax liabilities. This brings a certain level of concern to acquirers under distressed M&A as to the tax liabilities that can affect the business going forward.
The general protection applicable to the disposal of isolated productive units also covers tax liabilities. Indeed, the National Tax Code sets forth that the acquirer of assets comprising a going concern within the context of a judicial sale of a UPI of a company under bankruptcy or judicial reorganisation does not inherit the tax liabilities attached to such a going concern. This protection is lifted if the acquirer is a related party to the seller.
If the acquisition of a distressed asset is not implemented under the format of a judicial sale of a UPI, general tax succession rules will apply whereby the buyer will become subsidiarily liable for the taxes inherent to the business developed with the acquired going concern if the seller continues its transactions (or new transaction) in the following six months. If the seller discontinues its activities, the buyer becomes jointly liable for the tax liabilities attached to the going concern. Other tax succession liability rules may apply, depending on the format of the acquisition.Auction versus single-buyer sale process
What are the respective pros and cons of auction sales and single-buyer sales? What rules and common practices apply to each?
Pursuant to the Brazilian Bankruptcy Law, for a sale under a reorganisation proceeding to be carried out free and clear from the liens and liabilities of the debtor it must be performed as an auction or a competitive process, which provides protection for buyers against succession liabilities of the debtor. However, auction sales are typically more complex and may take longer than single-buyer sales. The auction sale must be provided for in the reorganisation plan approved by the creditors and confirmed by the bankruptcy court. Following court confirmation of the plan, the auction sale may be implemented. Before the amendment of the Brazilian Bankruptcy Law, the auction sale had to be public and preceded by the publication of court notices. After the amendment, the Brazilian Bankruptcy Law provides for an alternative competitive process organised and conducted by a specialised agent and such a process shall be detailed in the reorganisation plan, which may expedite auction sales performed in the context of reorganisation proceedings.