Distressed Mergers and Acquisitions: Lessons from the Venezuela Experience
This is an Insight article, written by a selected partner as part of Latin Lawyer's co-published content. Read more on Insight
Downturns in macroeconomic conditions and challenges resulting from political turmoil create an environment that tends to make traditional M&A transactions harder to conceive and consummate. However, there is plenty of experience around the world on distressed M&A - that is, transactions where the target is undergoing a significant negative period of performance and is at risk of bankruptcy, shutdown or other inability to operate under its existing model. This chapter will provide some examples of various triggers and features frequent in distressed M&A transactions, using the Venezuelan experience of the past decade.
Venezuela has had its fair share of distressed M&A activity in recent years owing to its well-known and continued political and economic crisis. But this surge in distress only began a few years ago as a result of the worsening of the economic crisis and the lack of alternative viable ways for business owners to exit the Venezuelan market.
We have extracted some lessons from our experience advising buyers and sellers in this growing distressed M&A scene and will try to translate these lessons into the description of the principal features of a Venezuelan distressed M&A deal, which we believe can be useful in other jurisdictions as they face moments of crisis.
Evolution of M&A in Venezuela
The decade that preceded Hugo Chávez’s election to the presidency of Venezuela in 1998 was marked by traditional M&A activity and a wave of privatisations.
The first years of Hugo Chávez’s tenure (1999-2006), while politically unstable, were still marked by traditional M&A activity and the opening of some sectors to foreign investment. These years saw significant takeovers of large listed companies.
From 2006 to 2013, the government nationalised several industries as part of its policy of reducing the influence of multinational corporations. These nationalisations were fuelled by a surge in oil prices, and were carried out either through outright nationalisations (in many cases without compensation to the owners of the nationalised businesses or assets) or negotiated M&A transactions (i.e., mergers and nationalisations (M&Ns)).
The year 2014 was marked by political upheaval, and Venezuela has remained politically and economically unstable to this day as a result of the collapse of oil prices and Venezuela’s oil production, the political situation, deadlock and US sanctions. This situation has left the country with a strikingly smaller economy and internal demand for goods and services. The government – now with emptier coffers – lost its appetite for nationalisations and M&Ns. This period has been marked by stringent price controls, resulting in significant shortages of most consumer goods, strict foreign exchange controls that criminalised black market foreign currency transactions (all the while, the official exchange rates were kept artificially low, creating huge gaps between the official rate and the black market rate) and one of the highest and most prolonged hyperinflation in contemporary world history. As a result of these challenging conditions, several multinationals decided to exit the country. While some of them decided to shut down their operations in Venezuela, others decided to sell their operations to third parties, triggering a number of distressed M&A transactions.
Triggers and principal features of distressed M&As in Venezuela
As mentioned above, the beginning of the recurrent distressed M&A activity in Venezuela can be traced to the beginning of 2014. We will try to describe the most influential causes that have triggered distressed M&A activity. We will then look into the principal features of distressed M&A deals in Venezuela.
On the one hand, exiting Venezuela became necessary for many multinationals in recent years because of the challenges to operate a business in Venezuela (the ‘operational trigger’). On the other hand, liquidating or winding down the business, or shutting down operations in Venezuela altogether, is unfeasible or raises significant risks and, therefore, the sale of the operations to a third party became the most viable alternative (the ‘legal trigger’). These two triggers account for the increase in distressed M&A activity in Venezuela in recent years.
Venezuelan businesses have become increasingly difficult to operate over the past years for a number of reasons.
While inflation had characterised Venezuela’s economy for many years, the second half of the 2010s was marked by a record-breaking hyperinflation accompanied by a lack of public estimates and data by the Venezuelan government for many of those years (until recently, the Central Bank had plainly stopped issuing such estimates). Needless to say, hyperinflation has had pervasive effects on the management of Venezuelan businesses, ranging from increased difficulties in making sense of the entity’s accounting (several multinationals deconsolidated their Venezuelan operations to isolate their adverse financial and accounting effects), coming up with suitable and viable solutions for employees’ compensation (salaries in local currency quickly lost their purchasing power) or the virtual destruction of local currency financing options.
The strict foreign currency exchange system criminalised black market foreign currency transactions, while the government drastically reduced the offer of foreign currency through official auctions and kept the official rate artificially low. This situation, coupled with the collapse of oil prices, triggered one of the greatest currency devaluations in history. The huge gap between the official and black market rates causes significant accounting distortions.
The foreign currency authority virtually stopped accepting requests to remit dividends abroad at the official rate. This often left multinationals with no other option but to reinvest any profit they could generate into their Venezuelan operations to mitigate the hyperinflation’s effect on the value of local currency profits.
Stringent price controls set a 30 per cent profit margin cap and did not allow companies to take into account most of their overhead costs and hyperinflation to calculate their profit. The government also fixed prices for certain goods, which were sometimes frozen over long periods of time, forcing companies to sell goods at a significant loss. Price control regulations were also used as a basis for recurrent and excruciating audits by government officials that, in some cases, ended with the imposition of fines, temporary closures of the business, seizures and criminal prosecution of key employees.
Labour freezes have remained in force for many years. Under Venezuelan law, employees cannot be unilaterally terminated by the employer without cause. Termination of employees for cause (such as theft, absenteeism) has become practically impossible because terminations must be approved by government officials (inspectores del trabajo), who rarely do so. Thus, terminations have to be achieved by negotiating enhanced termination packages with the employees to incentivise their resignation. Union leaders, health and safety delegates and employees on maternity or sick leave are under special protection and may require tailor-made termination packages in exchange for their resignations.
Decreases in the quality of life due to the adverse conditions in the country (hyperinflation, insecurity, food and medicine shortages, long-lasting blackouts or recurrent brownouts) make it harder for companies to retain much-needed talent, which prefers to leave the country seeking more stable environments. Often, key employees are based outside the country for these reasons, posing additional challenges for coordinating internal procedures and dealing with crucial meetings with government officials.
International and US sanctions pose additional challenges for operating in Venezuela, especially for companies owned by US multinationals. Day-to-day commercial or financial transactions clearly out of the scope of sanctions take much more time to close due to KYC and due diligence procedures, and in many cases are stopped from closing altogether out of excess of caution. US companies depend on the issuance of general or particular Office of Foreign Assets Control (OFAC) licences to continue operating, building uncertainty for long-time commitments in the country.
The cost-benefit analysis of operating in Venezuela owing to Foreign Corrupt Practices Act (FCPA) or similar regulations is also relevant to companies owned by foreign multinationals. These companies have to deploy strict compliance programmes and ensure management oversight of the entity’s dealings owing to the levels of reported corruption in Venezuela.
The ever-present nature of the challenges of the Venezuelan political and economic environment makes multinationals spend an ever-growing amount of managerial time having to deal with such challenges. Similarly to the cost-benefit analysis of having FCPA compliance programmes, the trade-off between managerial time and profits for the headquarters becomes less convenient with the passing of time given the shrinking of Venezuela’s economy and its near future uncertainty.
Notably, debt pressure is omitted as an operational trigger due to hyperinflation wiping out the companies’ debt burden.
From a legal standpoint, the main trigger for the sale of distressed businesses in this period of economic crisis is the lack of other viable alternatives to exit the country.
Under Venezuelan law, it is not possible to unilaterally liquidate a business as a way to exit the country. As mentioned above, employees cannot be unilaterally terminated by the employer without cause, and voluntary liquidation is not a cause for the termination of employees under Venezuelan law.
In light of this, some multinationals have exited the country by permanently shutting down their operations in Venezuela while maintaining the legal vehicle, paying all labour obligations with their employees and debt with their suppliers. However, in many cases, the shutdown has triggered a strong reaction from the government, including the criminal prosecution of key employees based in the country arguing economic destabilisation, boycott, labour breaches or otherwise. In addition, the government has the legal power to ‘temporarily intervene’ companies to ‘protect employment’. After these interventions, the government has started operating the businesses and even kept manufacturing the same branded products without the consent of the owner of the brand.
Given the risks involved in a shutdown of the operations, the sale of the operations to a third party became an effective way to exit Venezuela.
One of the most salient features of distressed M&A activity in Venezuela is that it occurs outside of insolvency proceedings for two reasons. On the one hand, businesses have low amounts of debt mainly because local currency financing got diluted by hyperinflation, and the only significant foreign currency denominated debt is generally intercompany debt. On the other, the existing insolvency processes contemplated under Venezuelan law are old and ill-equipped to liquidate the insolvent company. This causes the owner of the Venezuelan business to avoid the lengthy and uncertain insolvency proceedings and aim for an out-of-court sale of their businesses.
Type of buyer
The buyer of a distressed transaction in Venezuela typically has a considerable tolerance for risk and bets on a political or economic change. There are even private equity funds that are actively looking for opportunities and have shown interest in these types of divestitures, especially because they tend to be completed in exchange for little or no consideration, which could be translated into sizeable profits come a more stable political or economic environment in the near future.
In addition to private equity funds, typical buyers include family offices of high net worth individuals from Venezuela, Latin America and Europe. The family offices’ streamlined decision-making process, secrecy and focus on investments with an indefinite time frame give them a significant competitive edge. Other institutional investors and global strategic players are uncommon.
One critical task that must be dealt with from the outset of the transaction is to conduct a thorough due diligence on the potential acquirer to confirm that it is not under any international or US sanctions, or otherwise raises reputational issues.
Financial debt generally does not pose challenges for closing because external financing operations have rarely occurred in recent years. Venezuelan operations have been largely financed by their shareholders merely to stay afloat. In these transactions, inter-company debt is generally capitalised before the sale or is transferred to the buyer. And as mentioned above, local currency financing became diluted by hyperinflation.
‘As is’ transfer
Transfers are typically made on an ‘as is’ basis, with very limited sellers’ representations and warranties and indemnity obligations. Sellers’ representations and warranties are generally limited to ‘fundamental representations’, that is, representations and warranties relating to organisation and standing, capitalisation, powers and authority, consents and approvals and title, and representations and warranties related to anti-money laundering (AML), anti-corruption, and trade sanctions. Sellers typically require that buyers provide representations and warranties related to organisation and standing, powers and authority, consents and approvals, sources of funds, no financing condition, AML, anti-corruption and trade sanctions, as well as nonreliance provisions. R&W insurance is not currently feasible given local conditions, and political and economic risk insurance is not available.
Asset purchase versus stock purchase
Sales are generally structured as stock transactions. Asset deals are very uncommon, as they are very complex to structure and in most cases trigger regulatory approvals that are not required in stock transactions; for example, in an asset deal, environmental, sanitary, industrial and other permits must be amended or reissued by regulatory authorities, which may significantly delay the closing of the transaction. Asset deals may also raise significant tax liabilities. In addition, asset deals may have to comply with local bulk transfer requirements to protect purchasers from pre-closing non-transferred liabilities of the target’s business, and compliance with such bulk transfer requirements does not properly isolate purchasers from labour and tax liabilities of the target’s business. Under local law, purchasers are jointly and severally liable with the seller for the tax liabilities of the target’s business for a certain period following the notice of transfer to the tax authorities.
Purchase price and valuation methods
Purchase prices are distressed mainly because of the country’s uncertain near-term future. The price is generally paid at closing in US dollars or other foreign currency in bank accounts located outside Venezuela, as there are no local foreign currency exchange or other restrictions to do so. Prices are generally not subject to adjustment for working capital, net financial debt or other pre- or post-closing adjustments. Selling at distressed prices sometimes results in accounting losses to the selling shareholders. In certain cases, the price has been nominal, as sellers’ elimination of their country risk, operating expenses and ongoing liabilities may be sufficient consideration.
Valuation methodologies used in distressed M&A transactions taking place in other jurisdictions (such as adjusted DCF valuation, comparable company analysis, precedent transactions, etc.) are seldom used in Venezuela given the extreme difficulty in forecasting future cashflows in hyperinflationary economy fraught with political risk, and given the limited amount of publicly available transaction data. In many cases, sellers quantify the operating expenses and ongoing liabilities they will have to continue to incur if they don’t sell the business, and buyers estimate how fast they will get the purchase price back and how the company would be valued in a normalised economy. Buyers will often look at the investment as a call option on a Venezuelan political or economic change and recovery that would lead to significant valuation re-rating. In these cases, an analysis of the company’s staying power, market position, and ability to generate cash under all macro conditions is key.
In some cases sellers engage the services of investment bankers (commonly local boutiques or regional players) to assist them in the selection of potential buyers, negotiation of price and other financial terms and due diligence process. Purchasers seldom engage investment bankers. Many transactions do not involve investment bankers at all.
Given the scarcity of skilled local talent, distressed M&A transactions often include agreements to retain the top management of the Venezuelan business being sold.
Simultaneous signing and closing
Except for transactions involving companies operating in regulated sectors (such as insurance, banking and telecom), signing and closing take place simultaneously. Unlike most of the other countries of the region, antitrust filings are not mandatory in non-regulated sectors in Venezuela. When signing and closing are simultaneous, sellers run the expropriation risk until the transaction is consummated. If signing and closing are not simultaneous (for regulatory or other reasons), then purchasers typically negotiate the inclusion of no expropriatory acts as a closing condition and the occurrence of expropriatory acts as cause for termination of the transaction.
As signing and closing usually take place simultaneously, pre-closing covenants (such as conduct of business) are usually not included. In certain transactions, purchasers have accepted post-closing covenants relating to continuation of the business and treatment of employees. However, in general, purchasers are reluctant to accept such covenants. In any event, as mentioned above, under current conditions it is very difficult for purchasers to discontinue the business, break up the company for its assets, or unilaterally terminate employees.
In certain transactions, sellers negotiate an option to repurchase the Venezuelan business at a significant premium. This option allows sellers to re-enter the Venezuelan marketplace if the political or economic conditions improve. Given the significant uncertainties on the political and economic prospects of the country, it is generally very difficult to agree on a valuation method to calculate the repurchase price.
Governing law and dispute resolution
There are no restrictions under Venezuelan law for the sale of the equity interests of a Venezuelan company to be governed by foreign law. Distressed M&A transactions are governed by Venezuelan law, New York law or the law of the jurisdiction of one of the parties.
The parties to the distressed M&A transactions generally agree to subject their contractual disputes to arbitration seated in cities outside Venezuela (Miami is a fairly common choice). Venezuela is a party to the 1958 New York Convention.
As mentioned before, sellers generally provide limited representations and warranties and related indemnity obligations, buyers are willing to agree on very few covenants, and purchase price adjustments are uncommon. Therefore, sellers’ and buyers’ contractual liabilities are limited and so are post-closing challenges, as buyers assume the risk of several post-closing challenges that are inherent to a distressed business. The few disputes arising from the transactions tend to be solved through negotiation rather than arbitration or litigation.
The fact that M&A activity continues in Venezuela despite one of the longest and most devastating crises in modern history suggests some cause for optimism in that there are those willing to bet on the country’s future. Only time will tell if such investors are wildly successful contrarians. Investors in other Latin American economies should be heartened that dogged determination will enable them to close deals even in the most trying circumstances.
 Fulvio Italiani is a partner and Giancarlo Carrazza is an associate at D’Empaire. The information in this chapter was accurate as at December 2020.
 Notable privatisations included: CANTV, Venezuela’s largest telecom services provider in 1991 (the VenWorld Consortium, led by GTE Corporation (now Verizon), purchased 40 per cent of CANTV’s capital for an amount of US$1.8 billion); Viasa, Venezuela’s then flag carrier in 1991 (Iberia, together with Banco Provincial, purchased 60 per cent of Viasa’s capital for an amount of US$145.5 million); and Sidor, Venezuela’s largest steel producer in 1998 (the Amazonia Consortium, a group of Latin American steel producers led by Argentina’s Siderar, purchased 70 per cent of Sidor’s capital for US$1.2 billion). This decade also saw the opening of the oil industry to private investment – apertura petrolera – through the award of strategic associations, profit-sharing and operating agreements to international oil and gas companies.
 Notable takeovers and takeover attempts included: La Electricidad de Caracas (EDC), Venezuela’s largest utility company in 2000 (AES Corporation purchased 87 per cent of EDC’s capital through a US$1.66 billion unsolicited dual tender offer for the shares and ADRs of the company in Venezuela and the United States); AES then tried to acquire 43.2 per cent of CANTV’s capital through a US$1.37 billion unsolicited dual tender offer in 2001, but AES withdrew the offer as a result of the September 11 attacks and CANTV’s rejection of the offer (‘AES Withdraws Its Bid For Venezuela’s CANTV’, https://www.wsj.com/articles/SB1005145018782374000); Digitel, a major mobile telecom operator in 2000 (Telecom Italia purchased 55.6 per cent of Digitel’s capital in 2000, and then sold 100 per cent of its interest to Grupo Televenco in 2006 for US$425 million); and Mavesa, one of Venezuela’s largest food manufacturers in 2001 (Grupo Polar, Venezuela’s largest industrial conglomerate, purchased 100 per cent of Mavesa’s capital pursuant to a US$480 million dual tender offer for the shares and ADRs of the company in Venezuela and the United States).
 Notable outright nationalisations included: ConocoPhillips’ stake in the Petrozuata, Hamaca and Corocoro oil projects (2006–2007); ExxonMobil’s stake in the Cerro Negro oil project (2006–2007); Cemex’s stake in its local subsidiary (2008); Sidor (2008) (several months after the announcement of the nationalisation of Sidor, the Venezuelan government and the shareholders of Sidor reached a settlement agreement in May 2009 that contemplated the payment of a compensation of US$1.97 billion); and Owens-Illinois’s stake in its local subsidiary (2010). This wave of nationalisations led to a surge in the number of international litigation cases against Venezuela, many of which concluded with the issuance of multimillion-dollar awards that have been either settled or are now in the process of being enforced, mainly before US courts.
 M&Ns were accomplished through a formal or informal announcement by the government of its desire to nationalise a company followed by a negotiation of the purchase of the company by the government using traditional M&A tools (due diligence, negotiation of stock purchase agreement and, in some cases, tender offers in the capital market). The transactions followed political pressure that induced shareholders to quickly reach the best possible deal they could get to avoid an outright nationalisation with a lower compensation (or no compensation at all). After the government had already showed that it would not think twice before carrying an expropriation, it is no surprise that many of these deals were closed. Notable M&Ns included: CANTV in 2007 (Verizon sold its entire stake in CANTV (28.5 per cent) to the Venezuelan government for US$572 million pursuant to a US$1.3 billion dual tender offer for the shares and ADRs of the company in Venezuela and in the United States. The announcement of the nationalisation of CANTV followed the joint offer by Telmex and América Móvil to purchase CANTV, pursuant to an unsolicited dual tender offer for the shares and ADRs of the company in Venezuela and in the United States; this offer was withdrawn by Telmex and America Móvil as a result of the nationalisation announcement); La Electricidad de Caracas (EDC) in 2007 (AES Corporation sold its entire stake in EDC (82 per cent) to the Venezuelan government for US$739 million following the announcement of its nationalisation. The purchase was made pursuant to a dual tender offer of the shares and ADRs of the company in Venezuela and the United States); and Banco de Venezuela, Venezuela’s largest bank in 2009 (Banco Santander sold its entire stake in Banco de Venezuela to the Venezuelan government for US$1.05 billion).
 ‘Oil Industry Is Fading Away in Land of the World’s Richest Reserves’, https://www.wsj.com/articles/oil-industry-is-fading-away-in-land-of-the-worlds-richest-reserves-11599238961.
 ‘Gross domestic product shrank from about $196 billion in 2013 to some $80 billion last year, smaller than that of Guatemala or Ethiopia’. See: ‘Venezuela’s Economic Collapse Explained in Nine Charts’, https://www.wsj.com/articles/venezuelas-economic-collapse-explained-in-nine-charts-11553511601?mod=article_inline.
 Given the critical economic situation of Venezuela, the government recently started to ease several government controls affecting the economy (‘Maduro Gives Economy a Freer Hand to Keep His Grip on Venezuela’, https://www.wsj.com/articles/maduro-gives-economy-a-freer-hand-to-keep-his-grip-on-venezuela-11580380203). The government repealed foreign exchange regulations criminalising foreign currency exchange transactions and the sale of goods and services in foreign currency. The Venezuelan economy has become informally dollarised; an increasing number of transactions are settled in US dollars, but banks remain shy from opening US-dollar-denominated accounts due to opaque regulations, and taxes and other duties are still payable in local currency exclusively. Price control regulations have not been enforced as much as in previous years, except for a few notable cases (in April 2020, the government enforced price control regulations against Polar, Plumrose and Coposa, three large food manufacturers). The government has also aggressively promoted imports by eliminating import tariff and duties. We have yet to see if these measures will be sustained in time and what effects, if any, will they have on M&A activity. For the time being, these measures do not appear to be part of a broader economic plan, but makeshift solutions aimed at easing social tensions caused by the deep economic crisis.
 Notable M&A transactions during this period included: the sale of Plumrose’s Venezuelan subsidiary (2014); the sale of Dana’s Venezuelan subsidiary (2015); the sale of Bridgestone’s Venezuelan subsidiary (2016); the sale of General Mills’s Venezuelan subsidiary (2016); the sale of Pirelli’s Venezuelan subsidiary (2018); the sale of Zurich Seguros by Zurich Insurance Group (2018); the sale of Seguros Caracas, Venezuela’s largest insurance company, by Liberty Mutual (2019); and the sale of Cargill’s Venezuelan subsidiary (2020).
 Fulvio Italiani and Carlos Omaña, ‘Navigating a Corporate Crisis: Managing the Risks of Downsizing in Venezuela’, in The Guide to Corporate Crisis Management, 2nd ed, 2019: p. 28.
 Under the Code of Commerce’s winding-down rules, the shareholders’ may resolve to wind down a company for any reason, before the expiration of its duration as set forth in its by-laws, and designate one or several liquidators that will undertake all actions necessary to wind down the company. See Fulvio Italiani and Carlos Omaña, ‘Restructuring 2019: Venezuela’, in Latin Lawyer Reference.
 See ‘Venezuela Takes Over Plants Left by U.S Firm Clorox’, https://www.reuters.com/article/us-clorox-venezuela/venezuela-takesover-plants-left-by-u-s-firm-clorox-idUSKCN0HL2FW20140927; ‘Is It the End? Venezuela Takes Over Kimberly Clark Operations’, https://www.barrons.com/articles/is-it-the-end-venezuela-seizes-kimberly-clarkoperations-1468342351; ‘Kellogg Pulls Out of Venezuela, Citing Its “Deterioration”’, https://www.wsj.com/articles/kellogg-pulls-out-of-venezuela-citing-its-deterioration-1526419980.
 Organic Labour Law, Article 145. Pursuant to this law, the Ministry of Labour has the power to designate an intervention committee, albeit including members to be designated by the shareholder, and delegate this committee with the power to manage the company. See Fulvio Italiani and Carlos Omaña, ‘Navigating a Corporate Crisis’, op cit, p. 28, footnote 7.
 ‘Kellogg’s to Take Legal Action Against Venezuela for the Improper Use of the Brand after Expropriation’, https://www.brandsprotectionnews.com/en/kelloggs-to-take-legal-action-against-venezuela-for-the-improper-use-of-the-brand-after-expropriation/.
 Proceedings may last from several months to several years. See Fulvio Italiani and Carlos Omaña, ‘Insolvency Proceedings in Venezuela: A 19th Century Statute is Ill-Equipped to Navigate Current Times’, in Emerging Markets Restructuring Journal, 2017, 4.
 Fulvio Italiani and Carlos Omaña, ‘Navigating a Corporate Crisis’, op cit, p. 27.