Structure and process, legal regulation and consents
How are acquisitions and disposals of privately owned companies, businesses or assets structured in your jurisdiction? What might a typical transaction process involve and how long does it usually take?
The most common way to structure an acquisition or disposal of privately owned companies, businesses or assets in Ecuador is through the direct sale and purchase of the shares.
The Ecuadorian market is increasingly becoming the stage for several types of business combinations. Mainly horizontal combinations, that have brought competing firms together under single ownership, and vertical combinations, resulting from the integration of businesses that are engaged in different stages of production. The main structures available for business combinations are the following:
- statutory mergers - resulting from a combination where one company continues to operate and the other is liquidated into the survivor;
- statutory consolidations - resulting from a business combination resulting from two companies being liquidated into a newly created organisation;
- acquisition of shares - where a company acquires a percentage of another company’s stock in order to be able to set and enforce operating policies;
- acquisition of assets - acquisition of assets rather than stock;
- spin-offs - which result in the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company; and
- joint ventures - a contractual agreement that results in two parties joining to undertake a particular business.
The Ecuadorian Companies Act establishes the following two types of mergers:
- when two or more companies merge to form a new one that acquires its rights and obligations; and
- when one or more companies are absorbed by another that continues to subsist.
A typical deal involves:
- the subscription of a non-disclosure agreement and memorandum of understanding (MOU) or letter of intent (LOI) including the main terms of the transaction and generally established an exclusivity period to negotiate the potential deal;
- a due diligence process on the target company;
- the subscription of a share and purchase agreement (SPA) and supplementary documentation (eg, transitional services agreements (TSAs), service level agreements (SLAs) and corporate documents for the replacement of management bodies);
- filing of a merger clearance notification (should the applicable threshold be met) within 8 days of signing the SPA; and
- closing, including all the formalities for a valid transfer of shares.
This process usually takes eight to 12 months, especially in cases that require a merger clearance process, which usually take around five to seven months.
Which laws regulate private acquisitions and disposals in your jurisdiction? Must the acquisition of shares in a company, a business or assets be governed by local law?
Depending on the type of company, its industry or the sector of the economy in which it operates, different laws and regulations will be applicable to business combinations. In general, the legal framework governing business combinations in Ecuador is comprised by the following laws and regulations:
- Ecuadorian Companies Act, enacted on 5 November 1999;
- Antitrust Regulation: The Organic Law for the Regulation and Control of Market Power, enacted on 13 October 2011;
- Resolution No. 4 issued by the Superintendence of Companies for the Regulation of the Transfer of Shares, enacted on 8 May 2013;
- Internal Tax Regime Law, enacted on 17 November 2004;
- Regulation of the Internal Tax Regime Law, enacted on 8 June 2010;
- Organic Act for Production Incentives and Tax Fraud Prevention, enacted on 29 December 2014; and
- Reformatory Law for Fair Taxation, enacted on 29 December 2007.
All business combinations that take place in Ecuador or involve Ecuadorian entities are bound by local laws and regulations. However, parties can typically choose the applicable law during the transaction, as long as these do not contravene Ecuadorian legislation. The parties are bound by domestic law in order to enforce contractual obligations and indemnifications before Ecuadorian courts. To enforce an award, granted by a foreign judge or arbitrator, Ecuadorian judges will analyse the case’s substance and form subject to Ecuadorian law. Thus, parties will often choose Ecuadorian law for transaction agreement. However, parties usually feel more comfortable and prefer a neutral foreign jurisdiction for arbitrational procedures.
What legal title to shares in a company, a business or assets does a buyer acquire? Is this legal title prescribed by law or can the level of assurance be negotiated by a buyer? Does legal title to shares in a company, a business or assets transfer automatically by operation of law? Is there a difference between legal and beneficial title?
Title over the shares is automatically transferred from the seller to the buyer once the formalities for transfer of shares have been fulfilled. For limited liability companies the transfer of shares is completed when the public deed of transfer of shares along with the shareholders’ meeting minutes stating that there has been unanimous consent for the transfer the shares, is duly executed in the mercantile registry. However, in Corporations, the transfer of ownership of the shares will not be effective against the company or third parties until the date of its registration in the book of shares and shareholders.
This registration shall be validly constituted with the sole signature of the legal representative of the company, upon being notified of such transfer by the assignor and the assignee.
In the case of shares registered in a stock exchange, entry in the stock and shareholders’ ledger shall be made by the centralised securities deposit, on presentation of the transfer form signed by the securities firm acting as an agent for the transfer of shares. The centralised deposit will maintain the files and records of the transfers and will notify the company on a quarterly basis, for which purpose it will keep the stock and shareholder ledger with the corresponding list of shareholders.
Ecuadorian law forbids the establishment of requirements or formalities for the transfer of shares, which are not expressly indicated in the law, and any statutory or contractual stipulation that establishes such requirements or formalities shall have no value whatsoever.
Specifically in relation to the acquisition or disposal of shares in a company, where there are multiple sellers, must everyone agree to sell for the buyer to acquire all shares? If not, how can minority sellers that refuse to sell be squeezed out or dragged along by a buyer?
There are no legal provisions in Ecuador authorising the squeeze-out (ie, mandatory sale of shares) of minority shareholders. In limited liability companies unanimous consent is required for the transfer the shares.
However, the Companies Act establishes that minority shareholders are entitled to separation when in disagreement with certain shareholders’ meeting decisions such as mergers or transformations. Thus, the company will have to reimburse the separating shareholder’s shares.
In Ecuador, a majority position may accomplish a squeeze-out though capital increases by diluting minority shareholders. Ecuadorian law allows for corporation shareholders to participate in any call for additional capital in proportion to their ownership; therefore, dilution would occur only when the minority shareholder is unwilling or incapable of contributing further capital.
With regards to partnerships, article 114 of the Companies Act states that shareholders have a right to not be forced to a capital increase. Thus, limitations to capital increases can be established in the company’s by-laws protecting minority shareholders.
Exclusion of assets or liabilities
Specifically in relation to the acquisition or disposal of a business, are there any assets or liabilities that cannot be excluded from the transaction by agreement between the parties? Are there any consents commonly required to be obtained or notifications to be made in order to effect the transfer of assets or liabilities in a business transfer?
In the acquisition or disposal of a business through an ‘asset deal’, assets or liabilities can be excluded from the transaction by agreement between the parties. However, in ‘share deals’ the transfer of shares will encompass the transfer of all inherent assets and liabilities.
With regards to consents commonly required, in Ecuador government or stock exchange filings are merely for informational purposes; therefore, there are no filings required before the Superintendence of Companies in order to get clearance for business combinations. As per the Ecuadorian Companies Act, transfers of shares of companies incorporated in Ecuador need to be notified to the Superintendence of Companies within eight days of the closing date.
As per article 35 of the Financial and Monetary Act, when the transaction involves 10 per cent or more of the shares of a corporation listed in the Public Registry of the stock market, the parties must inform the Superintendence of Companies, five business days prior to the transaction completion date.
With regards to partnerships, the transfer of shares is completed when the public deed of transfer of shares along with the shareholder s’ meeting minutes stating that there has been unanimous consent for the transfer of the shares, is duly executed in the mercantile registry.
Regardless of the type of company being affected, other institutions may be notified, ex-post, about the business combination; such as labour, environmental institutions and tax authorities. Additionally, depending on the industry in which the company operates, additional filing and fees may be necessary prior to a business combination. In Ecuador, the sectors that are particularly regulated are natural resources, telecommunications and public services.
With regards to stamp taxes, article 352 of the Companies Act establishes that transfers of assets and liabilities, made in spin-off or merger processes are not subject to any provincial or municipal taxes, including income taxes and taxes on the gains from the sale of real estate.
However, request for clearance for the business combination must be filed with the Antitrust Authority when the following thresholds are met:
- operations where the total turnover exceeds 2000 basic salaries (basic salaries are subject to adjustments every year); and
- operations where economic operators that are engaged in the same economic activity obtain a market share of 30 per cent or more.
Competition regulation in Ecuador is relatively new considering that the Organic Law for Market Power Control and Regulation (LOCPM) was enacted on 13 October 2011. This law created the Superintendence of Control of Market Power, the governmental authority in charge of enforcing the LOCPM. The LOCPM establishes an ex ante system for requesting authorisation for mandatory economic concentration operations. According to the LOCPM, the Superintendence of Control of Market Power can authorise condition or deny the operation.
Are there any legal, regulatory or governmental restrictions on the transfer of shares in a company, a business or assets in your jurisdiction? Do transactions in particular industries require consent from specific regulators or a governmental body? Are transactions commonly subject to any public or national interest considerations?
In Ecuador, there are no foreign investment restrictions currently limiting the percentage of foreign ownership of equity capital in companies. Nor will the acquisition of an existing enterprise require obligatory screening and approval procedures, except for merger clearance approvals in cases where the applicable thresholds determined by the competition authority are met.
In the past seven years, laws that specifically regulate business combinations for media, mining, hydrocarbons and financial institutions have been enacted.
In 2012, the Ecuadorian National Assembly passed the Regulation for the Transfer of Shares of Media Companies; prohibiting that directors or major shareholders of private national communication companies to hold, directly or indirectly, stocks and shares in companies outside the communicational activity.
Hydrocarbons are also subject to additional regulations. As per the Hydrocarbons Act, the transfer or assignment of rights of the contracts for exploration and exploitation of hydrocarbons, as well as its related activities such as transport, storage, processing and marketing of hydrocarbons, is subject to an authorisation that must be issued by the corresponding line ministry.
With regards to financial Institutions, as per Resolution No. 3034 of the Superintendence of Banks, for business combinations involving institutions of the private financial system, the Superintendence of Banks and Insurance must qualify the responsibility, adequacy and solvency of the assignee, whether it is a national or foreign financial institution, prior to the registration of the transaction in the book of shares and shareholders.
Are any other third-party consents commonly required?
Other than regulatory filings mentioned below, third-party consents are not required by law. However, the consent of existing creditors, clients or suppliers, whose agreements contain change-of-control provisions is typically required as conditions precedent or closing deliverables.
Must regulatory filings be made or registration fees paid to acquire shares in a company, a business or assets in your jurisdiction?
Apart from the applicable taxes discussed below, there are no official fees that must be paid in order to acquire shares in a company, a business or assets in Ecuador. However, a merger clearance filing must be submitted with the competition authority when the following thresholds are met:
- operations where the total turnover exceeds 2,000 basic salaries (basic salaries are subject to adjustments every year); and
- operations where economic operators that are engaged in the same economic activity obtain a market share of 30 per cent or more.
In such case, a filing fee must be paid. The fee will be the higher value of the following concepts for all the economic operators in Ecuador that are part of the business combination: 0.25 per cent of the paid income tax, 0.005 per cent of the volume of sales, 0.010 per cent of Assets, and 0.05 per cent of shareholder’s equity.
Advisers, negotiation and documentation
In addition to external lawyers, which advisers might a buyer or a seller customarily appoint to assist with a transaction? Are there any typical terms of appointment of such advisers?
Depending on the size of the transaction buyers and sellers will opt to appoint external advisers such as financial advisers, tax consultants and accountants. Depending on the nature of the business, other advisers such as environmental or engineering consultants may also be appointed.
However, various transactions are regularly organised ‘informally’, that is, without the assistance of financial bankers, brokers of other hired consultants, and the transaction will be solely managed by external and in-house lawyers for both buyer and seller.
Duty of good faith
Is there a duty to negotiate in good faith? Are the parties subject to any other duties when negotiating a transaction?
Although there is no legal or statutory duty to negotiate in good faith, the Ecuadorian Civil Code establishes in article 1562 that contracts shall be performed in good faith and shall therefore be binding not only upon that which is expressed in them, but upon all things that arise precisely from the nature of the obligation or which, by law or custom, pertain to it.
What documentation do buyers and sellers customarily enter into when acquiring shares or a business or assets? Are there differences between the documents used for acquiring shares as opposed to a business or assets?
Parties entering business combinations will customarily enter into the following documents:
- a confidentiality agreement regarding the exchange of confidential information during the transaction;
- a MOU or LOI including the main terms of the transaction and generally established an exclusivity period to negotiate the potential deal;
- a SPA or asset purchase agreement (APA) establishing the terms of the transaction;
- disclosure schedules with regards to the representations and warranties contained in the SPA or APA;
- TSA or SLA governing the continued provision of services by the seller or its affiliates, post-closing;
- general shareholders’ meeting minutes approving the transaction; and
- shareholders’ agreements, when applicable.
Are there formalities for executing documents? Are digital signatures enforceable?
Digital signatures for private documents in Ecuador are not customary.
Depending on the nature of the document, several formalities must be applicable. Private documents do not generally require any formalities. However, documents that will be registered or filed within government authorities will require a notarised public deed.
Due diligence and disclosure
Scope of due diligence
What is the typical scope of due diligence in your jurisdiction? Do sellers usually provide due diligence reports to prospective buyers? Can buyers usually rely on due diligence reports produced for the seller?
Vendor due diligence is not usual in Ecuador, sellers will not usually provide due diligence reports to prospective buyers, and therefore, buyers will not commonly rely on due diligence reports produced for the seller. It is customary for buyers to perform their own due diligence exercise, assisted by external lawyers, financial advisers and accountants.
A ‘share deal’ will regularly involve a thorough due diligence on the following aspects of the company: corporate, labour, real state, tax, intellectual property, contracts, financial, environment, regulatory, litigation and insurance. Depending on the industry of the target several other aspects might be of importance during the due diligence phase.
An ‘asset deal’ will regularly involve a focus on corporate documents, as well as documents evidencing legal title of sellers over the assets that form part of the transaction and the condition or any liabilities that are related to such assets.
Liability for statements
Can a seller be liable for pre-contractual or misleading statements? Can any such liability be excluded by agreement between the parties?
It is not common for a seller to be liable for pre-contractual or misleading statements that are not captured in the text of the contractual documents. Except for fraudulent misrepresentations, SPAs will generally limit the seller’s liability to breaches of contract.
Publicly available information
What information is publicly available on private companies and their assets? What searches of such information might a buyer customarily carry out before entering into an agreement?
Corporate records and asset liens recorded with the Public Registry of Property are publicly available and, therefore, the buyer will customarily carry out a search on publicly available sources before entering into an agreement. Financial statements for the preceding fiscal year, along with the audit report for companies that require such formality, are also publicly available in the Superintendence of Companies website.
Impact of deemed or actual knowledge
What impact might a buyer’s actual or deemed knowledge have on claims it may seek to bring against a seller relating to a transaction?
Commonly the buyer’s actual or deemed knowledge on claims it may seek to bring against a seller relating to a transaction will result in the buyer having less probability of success in seeking an indemnity for a breach. Having knowledge on a certain contingency will generally still be subject to an indemnity but will regularly not constitute a breach, as the buyer was aware of such circumstance prior to closing.
Pricing, consideration and financing
How is pricing customarily determined? Is the use of closing accounts or a locked-box structure more common?
The price is normally determined by using customary methods for company valuation, the most common method used in Ecuador is the application of earnings before interest, taxes, depreciation, and amortisation multiples. Such consideration is generally subject to adjustment based on debt, working capital or inventory levels, either at or post-closing. The mechanics of the adjustments are agreed upon by the parties and included as annexes to the SPA. The use of closing accounts or a locked-box structure is less common in Ecuador.
Form of consideration
What form does consideration normally take? Is there any overriding obligation to pay multiple sellers the same consideration?
The consideration is normally takes the form of cash, payable at closing, and there is no overriding obligation to pay multiple sellers the same consideration.
Earn-outs, deposits and escrows
Are earn-outs, deposits and escrows used?
Yes, deposits and escrows are widely used. Although less common, earn-outs are also used. Escrows are commonly implemented to ensure funds are readily available for indemnity purposes.
How are acquisitions financed? How is assurance provided that financing will be available?
Every business combination agreement must indicate the consideration to be paid; however, there are no specific legal provisions regarding the source of financing for the transaction. Acquisitions are generally financed through existing funds in cash maintained by the buyer or external financing sought by the buyer or its affiliates.
However, it is common for the seller to require evidence of the buyer’s economic solvency to fulfil its payment obligations.
Limitations on financing structure
Are there any limitations that impact the financing structure? Is a seller restricted from giving financial assistance to a buyer in connection with a transaction?
There are no legal limitations that impact the financing structure. The decision will be based on tax efficiency and commercial terms. Likewise, there are no legal obligations for the seller to assist in the buyer’s financing and in Ecuador, it is not customary for sellers to provide any assistance in the buyers financing. However, parties are free to agree on financing conditions on private documents.
Conditions, pre-closing covenants and termination rights
Are transactions normally subject to closing conditions? Describe those closing conditions that are customarily acceptable to a seller and any other conditions a buyer may seek to include in the agreement.
Transactions are normally subject to closing conditions, such as:
- government authorities’ approvals (including antitrust);
- corporate (shareholder or board, or both) approvals;
- termination of related-party transactions;
- absence of a material adverse effect; and
- waivers from counterparties in key agreements to existing change of control covenants.
What typical obligations are placed on a buyer or a seller to satisfy closing conditions? Does the strength of these obligations customarily vary depending on the subject matter of the condition?
Normally, the SPA will establish reciprocal obligations on both parties to cooperate in fulfilling the conditions precedent where cooperation of both parties is required as well as the requirement of ‘reasonable efforts’ to fulfil closing conditions. This is the case for obtaining antitrust approval, where both parties will be required to cooperate in order to obtain a favourable resolution.
Are pre-closing covenants normally agreed by parties? If so, what is the usual scope of those covenants and the remedy for any breach?
The use of pre-closing covenants is common, especially in cases where acquisition transactions are structured with signing and closing scheduled to occur at separate successive dates. These will regularly address ordinary course of business commitments that could either be in the form of affirmative (actions) or negative covenants (prohibitions).
A seller’s breach of a pre-closing covenant would normally entitle the buyer to claim for damages; however, there are transactions where a breach of a pre-closing covenant could be a cause for unilateral termination of the agreement. It is also common for pre-closing covenants to be excluded from the limitations on the seller’s liability under a sale and purchase agreement.
Can the parties typically terminate the transaction after signing? If so, in what circumstances?
Yes, acquisition transactions where signing and closing are scheduled to occur at separate dates normally include a termination clause that allows for the bilateral or unilateral termination of the agreement.
A bilateral termination would occur by the mutual consent of the parties, and unilateral termination by either party would occur either when a governmental authority or regulator fails to approve the closing of the transaction or when there is a breach from one of the parties.
Regularly SPAs will include a ‘limit closing date’, should the parties not be able to fulfil the conditions precedent prior to the limit closing date, the agreement will be automatically terminated.
Are break-up fees and reverse break-up fees common in your jurisdiction? If so, what are the typical terms? Are there any applicable restrictions on paying break-up fees?
Break-up fees (for the seller to compensate the buyer for transaction costs) and reverse break-up fees (for the buyer to compensate the seller for abandoning the deal) are not common in Ecuador. It is common for each party to bear the costs and expenses for the transaction’s negotiation. However, break-up fees may occasionally apply in order to penalise a unilateral action or omission that prevents closing from occurring.
Representations, warranties, indemnities and post-closing covenants
Scope of representations, warranties and indemnities
Does a seller typically give representations, warranties and indemnities to a buyer? If so, what is the usual scope of those representations, warranties and indemnities? Are there legal distinctions between representations, warranties and indemnities?
Yes, in Ecuador it is common for the seller to give representations, warranties and indemnities to a buyer. Although there are no distinctions in the law, in Ecuadorian M&A practice there are two types: fundamental representations and warranties and general representations and warranties. This distinction will regularly serve to include a distinction on the survival period of such representations as well as the applicable caps, de minimis, basket or maximum. Fundamental representations and warranties generally comprise: the title to the shares and the capacity of the sellers, as well as the target entity’s existence and any consents or approvals required for the transaction. General representations and warranties will regularly comprise declarations on financial statements, taxes, environmental, labour, contracts, insurance, intellectual property, real estate, as well as compliance with laws, permits, and with anti-money laundering laws.
Limitations on liability
What are the customary limitations on a seller’s liability under a sale and purchase agreement?
Customary limitations include:
- a maximum cap of liability (normally ranging from 15 to 30 per cent of the purchase price). Such caps would not typically apply to the fundamental representations and warranties mentioned above, which are normally subject to a cap equal to the purchase price;
- a de minimis, where each individual claim must exceed a certain threshold;
- baskets, in which the buyer can claim damages that exceed only a certain threshold or can claim for the full amount of the losses (commonly referred to as a ‘tipping basket’); and
- statute of limitation periods or ‘survival clauses’, usually agreed between the parties, and for some aspects equal to the legal statute of limitation periods.
Is transaction insurance in respect of representation, warranty and indemnity claims common in your jurisdiction? If so, does a buyer or a seller customarily put the insurance in place and what are the customary terms?
Transaction insurance in respect of representation, warranty and indemnity claims is not common in Ecuador.
Do parties typically agree to post-closing covenants? If so, what is the usual scope of such covenants?
It is common to include non-compete and non-solicitation provisions that survive post-closing. Other than these, post-closing covenants are unusual.
Are transfer taxes payable on the transfers of shares in a company, a business or assets? If so, what is the rate of such transfer tax and which party customarily bears the cost?
Income tax on capital gains
The Organic Act for Production Incentives and Tax Fraud Prevention, enacted on 29 December 2014, established that capital gains generated from the direct or indirect transfer of shares is subject to income tax.
The company whose shares are subject to a change in ownership is responsible for withholding the amount payable for the capital gains tax, should the seller not comply with its payment obligation.
Currently, the tax rate is 35 per cent but a law is currently being discussed that establishes a tax rate chart up to 10 per cent.
Corporate and other taxes
Are corporate taxes or other taxes payable on transactions involving the transfers of shares in a company, a business or assets? If so, what is the rate of such transfer tax and which party customarily bears the cost?
Though tax implications may vary case by case scenario, the basic tax issues involved in business combinations in Ecuador are the following:
Income tax on capital gains
See question 31.
Capital outflow tax
The Reformatory Law for Fair Taxation introduced a 5 per cent capital outflow tax on the value of all operations and monetary transactions made abroad, thus applicable to all transfers of funds made abroad with or without the intermediation of financial institutions pertaining to the Ecuadorian financial system. Whenever the consideration of a business combination is paid abroad, it is subject to a 5 per cent capital outflow tax, even if the transfer of funds occurs aside the Ecuadorian financial system.
Value added tax on the sale of assets
The sale of fixed assets triggers a value added tax, equal to 12 per cent. This tax is not applicable for real state property.
Employees, pensions and benefits
Transfer of employees
Are the employees of a target company automatically transferred when a buyer acquires the shares in the target company? Is the same true when a buyer acquires a business or assets from the target company?
Yes, the employees of a target company automatically transfer when a buyer acquires the shares in the target company. This is not true when a buyer acquires a business or assets from the target company, in such case, only the title to the assets is transferred and no employees.
Notification and consultation of employees
Are there obligations to notify or consult with employees or employee representatives in connection with an acquisition of shares in a company, a business or assets?
There are no legal provisions that require a seller to notify or consult with employees or employee representatives in connection with an acquisition of shares in a company, a business or assets. This may not be the case in companies with individual or collective bargaining agreements entered into with employees, as these could establish the need for the seller to notify or consult with employees or employee representatives in connection with an acquisition of shares in a company, a business or assets.
Transfer of pensions and benefits
Do pensions and other benefits automatically transfer with the employees of a target company? Must filings be made or consent obtained relating to employee benefits where there is the acquisition of a company or business?
Yes, pensions and other benefits automatically transfer with the employees of a target company and there is no need for filings or consents relating to employee benefits where there is the acquisition of a company or business. Other than as might be provided for in collective bargaining agreements entered into with employees, there is no need to file or obtain consents from employees.
Update and trends
What are the most significant legal, regulatory and market practice developments and trends in private M&A transactions during the past 12 months in your jurisdiction?
Throughout the last decade, the Ecuadorian market has experienced a significant increase in private M&A transactions. There are various traditional, family-owned companies that are starting to sell their shares in Ecuadorian companies and this has resulted in an important inflow of foreign direct investment, both regional and global, into the country.
The political environment is gradually creating a pro-investment atmosphere that is giving rise to more complex transactions. It is now increasingly common to find transactions where external lawyers, financial advisers, brokers and accountants will cooperate to advise both buyers and sellers. More sophisticated elements in private M&A such as earn-outs, deposits and escrows are being used to secure buyers’ and sellers’ interests.
The prior tax rate on capital gains in Ecuador was 35 per cent. The recent law approved by the General Assembly has significantly reduced this rate by establishing a gradual chart with various tax rates, with 10 per cent being the highest. This will definitely turn investor’s eyes towards the Ecuadorian market and will further promote private M&A in the country.