Mergers and Acquisitions

Mergers and Acquisitions: Ecuador

Martín Pallares Sevilla

Ferrere

All questions

1. Has the level of M&A activity slowed, increased or remained flat in 2019 as compared to 2018, and what are conditions like today? In general terms, what level of activity is foreseen for 2020? What are the factors influencing the level of M&A activity – Economic? Political? Commodity prices? Weakness in currency? Stock market performance? Liquidity? Rule of law? Other?

Ecuador

The level of M&A activity in 2019 was slightly lower than 2018, mainly because of the  economic crisis that Ecuador is undergoing caused by the oil price drop in the previous years and excess foreign debt acquired by the government. Additionally, the current President has been working on solutions to decrease the economic crisis. Some of these regulatory solutions include tax amendments according to the regulations imposed by the IMF and World Bank in order to secure the disbursement of the loans committed by these institutions. Nevertheless, in the last quarter of 2019, the government attempted to eliminate diesel and gas subsidies as part of these reforms, which spawned national strikes that temporarily halted the economy of the country.

Private companies short on cash and seeking liquidity have opened up to the idea of looking for an investor party and contemplating selling their businesses as bailouts or even divesting from one or several business units through carveouts. Transnational companies and foreign investment funds have also pursued exit strategies in the Ecuadorian parts of their businesses, as a way to recuperate their investments from new eager investors who wish to try to turn them around.    

On the other hand, many multinationals have looked at various industries in Ecuador as investment targets taking into consideration that other countries in the region have already been invested in as they have been viewed as traditional investment countries.

The government has also become a notable player in the M&A sector, as it has and will be looking for financing for its state companies. The Foreign Commerce Minister has been very active internationally publicising potential investment ventures in Ecuador. This has encouraged the government to create new venture possibilities by selling stakes in their state companies or state subsidiaries, located mostly in developing strategic sectors such as oil, gas, energy, telecoms, transportation and media.

 

Answer contributed by Martín Pallares Sevilla

2. Which industries do you expect will see the most M&A activity in 2020?

Ecuador

The energy and oil and gas sectors will remain active in M&A. A consolidation in the insurance and banking sectors is still attractive, as well as many restructurings in retail, construction media and education.

In August 2018, the government also enacted a tax reform set out to promote new investments by incorporating tax exemptions and incentives, among other reforms, aiming to make the country more attractive. Among the incentives, there is an income tax exemption period of eight to 15 years on new or productive investments, performed in the prioritised sectors of the economy listed in the tax law and, depending on the region where such investment is located.

Answer contributed by Martín Pallares Sevilla

3. What types of deals do you expect to see?

Ecuador

Acquisitions of shares and equity interests are usual in Ecuador. It is also common to make considerable stock purchases in such operations, which give the acquirer control of the company (or companies) concerned. The volume of mergers is lower because mergers entail regulatory and corporative steps and procedures that may take several months. The National Assembly approved an amendment to the Ecuadorian Companies’ Law at the end of 2019, and part of the reforms included the possibility of creating mergers between companies from different jurisdictions, as well as making the merger procedure more flexible and expedient. Hopefully this will increase any acquisitions via merger procedures in Ecuador. There is also a low level of productive asset acquisitions.

Answer contributed by Martín Pallares Sevilla

4. Discuss the level of M&A activity you have seen over 2019 and expect to see in 2020 of: (i) pure domestic deals; (ii) deals in your jurisdiction involving a domestic target and foreign acquirer from Latin America, or a foreign acquirer from outside Latin America; and (iii) deals involving a domestic acquirer and foreign target in Latin America or a foreign target outside Latin America.

Ecuador

Although we have seen some purely domestic deals in the tech, energy and agricultural sectors, there have been very few of them. Most activity that will probably pick up this year are M&A deals centred heavily on real estate, manufacturing and retail. Deals involving foreign acquirers have dominated M&A activity in Ecuador and it is quite possible that they will continue to do so as foreign corporate groups in 2020 will seek to seize opportunities from the crisis. As for deals involving an Ecuadorian acquirer of foreign companies, there were few of them in 2019 and their activity in 2020 will depend on governmental regulations to encourage in Ecuador as opposed to other countries in the region.

Answer contributed by Martín Pallares Sevilla

5. What is the level of private equity activity? Are domestic or international funds involved? What kinds of deals are they doing?

Ecuador

We have seen a moderate increase in the activity of foreign equity funds, either solo or accompanying private corporate groups as the funding partners, mainly in the energy and natural resources sector. International funds have been involved utmost in transactions relating to energy, natural resources and infrastructure targets. Still, ordinarily fund activity is still pretty limited as against to the activity seen in neighbouring countries. There are few strong local funds that have continued to increase their activity this year seeking new opportunities. 

Answer contributed by Martín Pallares Sevilla

6. Is acquisition financing available for deals? Where is financing coming from? How much concern do you have that an increase in interest rates or risk of a recession will limit the availability of financing?

Ecuador

There has been no textbook acquisition financing but variations adapted to the Ecuadorian reality that may in some cases relate more to project financing. The “country risk” has not made deals in Ecuador as attractive as in other jurisdictions. Also, local financing entities have reduced their financing activity due to the lack of liquidity created by the economic crisis. Most of the financing seen has come from multilaterals. Deals with the state, for example, have been more prone to have an acquisition financing component and access to multilaterals. Overall, however, most acquisition financing seen has been in energy and natural resources deals.

Answer contributed by Martín Pallares Sevilla

7. How open is your country to investments and acquisitions by foreign buyers? Is there a level playing field when foreign and domestic bidders compete to buy the same domestic target company?

Ecuador

The Ecuadorian government has tried to make investments in Ecuador more attractive to foreign and local investors alike by enacting laws and regulations with tax holidays and legal benefits throughout these past couple of years. Among these benefits is the possibility of executing an investment protection agreement with the Ecuadorian government that allows any controversy to be disputed through international arbitration. In the first quarter of 2017, Ecuador denounced all executed bilateral investment protection treaties and communicated its intentions to terminate them. Currently only the Netherlands and Spain BITs are still in force due to sunset provision clauses. Ecuador is currently negotiating new BITs; however, the denouncement has increased the country’s investment risk abroad.    

While there are regulatory compliance requirements for certain strategic acquisitions (such as the standard anti-trust clearance or change of control authorisations), there are very few hard restrictions imposed on foreign investments. The most notable restriction lies on the media sector, where foreigners who do not reside in Ecuador or reside in countries without economic development treaties with Ecuador, are forbidden from acquiring more than 49 per cent of local media companies qualified as national companies.

Answer contributed by Martín Pallares Sevilla

8. Are corruption and compliance concerns affecting M&A activity? Are there industries where this is a particular issue?

Ecuador

Compliance requirements have become more popular in Ecuador, especially considering the amount of new foreign investors entering the scene, which seek to adapt local compliance regulations to the most notable FCPA or UK Bribery Act standards.

Also, Ecuador has seen its share of corruption scandals in the past couple of years, ranging from events occurring in state companies to international scandals from private companies on a global scale that end up having an impact in the country. One of the government’s flagship plans has been to prosecute public and private entities involved in corruption scandals.    

These events have raised awareness of anti-corruption and money laundering compliance in due diligence works, as well as the inclusion of specific provisions in SPAs in these regards, and continued advice throughout the closing process. In any M&A process, representing national or international clients, currently any major M&A practice is complemented with compliance experts with relevant international experience. 

Answer contributed by Martín Pallares Sevilla

9. How big a part of M&A activity is the restructuring of financially troubled companies? Have you seen more of this in 2019 as compared with 2018? What are the prospects for 2020?

Ecuador

In comparison with recent years, we can say that we have seen more deals of companies seeking funds, or an exit strategy from a troubled economic country in comparison to previous years. While there have not been any deals involving companies declared in bankruptcy per se, there have been bailouts of distressed companies. This has proven more common in the flower sector and oil-related industries.    

The lack of cash flow in the country has placed many companies in a distressed condition. Obtaining financing from local banks has proved difficult since it is fixed at high interest rates in comparison with the financing that may be obtained in international markets. International financing entities are more prone to lend financing; however, the risks involving in investing in the country have made them weary and cautious compared to the activity seen in neighbouring countries. This means that in 2020 we will probably continue to see a great deal of transactions involving restructuring of financially troubled companies. Given the constrictions in obtaining financing, this may be a great opportunity for high-risk investment funds to enter the scene.

Answer contributed by Martín Pallares Sevilla

10. Does your country’s bankruptcy law permit the reorganisation of the debtor as a going concern, and the acquisition of the entity out of bankruptcy? Are you seeing much activity in this area?

Ecuador

There have not been many companies declared bankrupt in recent years as the Concordat Law is antiquated and difficult to execute. That being said, there are no specific restrictions on the sale of shares of formally declared bankrupt companies. However, considering that the law imposes restrictions on the company’s dealings with its assets, this could be interpreted by tribunals as extending to its shares as well. Thus, permission on reorganisation would boil down to the acquiescence of the company’s creditors.

Answer contributed by Martín Pallares Sevilla

11. Has there been any increase in public company M&A?

Ecuador

Ecuador’s listed public scene is not as active as in other countries in the region. While the government has tried to include certain regulatory and tax benefits in activities involving publicly listed companies, these attempts have been too feeble to counter the general lack of trust of locals and foreigners in Ecuador’s capital markets. As such we have seen that the activity in public company M&A has remained stable over the years.

Answer contributed by Martín Pallares Sevilla

12. How well protected are minority shareholders in public companies? What recent developments have there been as relates to independent directors, special committees, independent advisers, fairness opinions?

Ecuador

Ecuadorian legislation has not developed minority shareholders’ protection measures further than the basic rights provided in the Companies Law. The law grants the following specific rights and protections to minority shareholders that individually or jointly have 25 per cent or more of a stake in a company: (i) the right to challenge any of the company’s administration bodies’ resolutions that they deem have been approved in prejudice of the company or of them; (ii) the right to compel the administration to summon a general shareholders’ meeting; (iii) the right to choose one Corporate Comptroller (Comisario) (akin to an internal, independent, auditor) when the company has three or more commissioners in place; and (iv) the right to compel the company to remove the chosen liquidator in the event of a liquidation of the company. 

Answer contributed by Martín Pallares Sevilla

13. Has there been any increase in shareholder activism and hostile takeovers? Are international hedge funds active in your market? What defences are target companies permitted to adopt?

Ecuador

While there are some emblematic cases of shareholder activism and hostile takeovers in Ecuador, there have been very few as the current regulations make it difficult to successfully enact these strategies. Furthermore, the activity of hedge funds is no more active than the activity of other funds.

Minority shareholders of target companies can always trigger their minority shareholders’ rights, including the right to have the target company’s administration be intervened by the Superintendency of Companies and evaluate if there have been any shareholders’ rights transgressions.

Answer contributed by Martín Pallares Sevilla

14. Have directors, management and controlling shareholders changed how they conduct themselves in M&A deals? What kind of fiduciary duties do directors, management and controlling shareholders have under the laws of your jurisdiction? From your experience, are directors, management and controlling shareholders more diligent today in their review of M&A transactions and other matters?

Ecuador

Besides the standard good faith, loyalty and care duties in the day-to-day running of the company and any other duty that may be specifically included in a company’s articles of incorporation, there are no other special obligations imposed on management bodies in M&A deals. Shareholders do not have any special fiduciary duties under Ecuadorian law. Thus, actions and attitude of management and shareholders have remained pretty much the same. 

Answer contributed by Martín Pallares Sevilla

15. Should directors, management and controlling shareholders be more concerned today about negative publicity, shareholder criticism, regulatory pressure, shareholder lawsuits and liability from potential litigation?

Ecuador

Shareholders and management have become more aware of criticism and regulatory pressure in deals where there are changes of control regulatory requirements. Historically in Ecuador this has been a hot topic, with many high-profile cases where compliance with these regulations have been debated and substantial compensation for damages has been claimed.

Ordinarily management who have the legal representation of the target company are legally liable for any breach of laws by the company, such as change of control. This has caused all parties in a deal to have carefully consider the regulatory aspects of a transaction. 

Answer contributed by Martín Pallares Sevilla

16. Are there major differences in how domestic and cross-border deals are being conducted? For instance, does the type of purchase agreement used in your jurisdiction differ significantly from the international style of agreement? If so, which type is being used more often?

Ecuador

The gap between local and international M&A differences has narrowed down during the past few years. Deals involving local or foreign parties alike have adopted more and more UK and US M&A standards. Transaction documents such as SPAs are now drafted in accordance with their house style, including sections such as representations and warranties and disclosure schedules, which is something that was not very common under the civil law regime.

Even though the civil, commercial codes and other ancillary legislation already regulate key parts of a transaction (such as which types of compensation is recognised under Ecuadorian law), this has not stopped parties from including specific contractual regulations in the documents as this would happen in other jurisdictions. 

Answer contributed by Martín Pallares Sevilla

17. Have there been changes in the process for how M&A transactions are conducted in your jurisdiction?

Ecuador

M&A deals in Ecuador have become more sophisticated, matching international standards. M&A transactions are usually conducted applying best practices and trends and technological support. 

Answer contributed by Martín Pallares Sevilla

18. How level is the playing field for domestic and international bidders?

Ecuador

Multinational buyers have less risk aversion that local ones, probably from their experience of dealing in many jurisdictions. Still, there are many legal risks that are difficult to avoid and assume for foreigners and locals alike, such as environmental and social security liabilities. Ecuadorian law states that these two liabilities have no statute of limitations. On the other hand, international buyers have less tolerance for compliance issues than local parties. In all of these cases we have seen strong indemnity provisions in the transaction documents.  

Answer contributed by Martín Pallares Sevilla

19. For international buyers and investors looking at deals in your jurisdiction, what are the three most important pieces of advice you have and what are the three most important pitfalls that should be avoided?

Ecuador

Ecuador may be seen as a simpler jurisdiction compared to its neighbours; however, its regulatory laws may in some cases be more complex. Underestimating the regulatory hurdles that the transaction must undergo may place parties in a tight spot, even trigger indemnities. Specially since certain regulatory requirements (such as anti-trust clearings) may take longer than in other jurisdictions. Therefore, our first recommendation would be to have a clear picture of how the transaction will have to develop, and the timing that clearing each requirement will take in order to manage expectations.

Regulatory complexity is especially true in tax matters. Ecuador’s tax law has tax penalties if a buyer uses vehicles incorporated in jurisdictions identified as tax havens by the Ecuadorian Tax Authority. This applies even to the capital gains that must be paid in a share purchase transaction. Thus, our second recommendation would be to have a clear tax structure for the transaction in order to maximise tax efficiencies in the deal, and operations of the target company afterwards.

Negotiation on robust indemnity mechanisms are a must. Ecuadorian law states that social security and environmental liabilities do not have a statute of limitations. When it comes to environmental liabilities, these may be cumbersome and difficult to assume. Obtaining compensation for these liabilities by triggering the transaction provisions may take some time. Thus, indemnity mechanisms (such as escrows or price discounts) may aid inremedying said liabilities. 

Answer contributed by Martín Pallares Sevilla

20. Have there been any significant regulatory developments affecting M&A – your country's securities exchange commission, antitrust regulators, tax authorities, Central Bank, other regulators that review deals etc?

Ecuador

At the end of 2019, the Law of Simplification and Progressiveness on Taxes was enacted, which has aimed to reform the tax regulations in Ecuador once more. There are a few important developments worth mentioning from this law:

  • The advanced income tax, which was a mandatory pre-payment of your income tax before any filings were due, has been repealed; therefore, the liability to pay this duty – which was an anticipated payment attributable to the income tax – will not be in force from the beginning of this year onwards.
  • The tax reform establishes an obligation to withhold 25% out of the 40% of the dividends paid abroad (which is approximately 10% of the dividends).
  • A temporary contribution has been created. Companies with economic activity and taxable income that is equal to or greater than US$1 million, are liable to pay this contribution in 2020, 2021 and 2022. The rates are 0.1%, 0.15% and 0.2% depending on what their income tax return is for fiscal year 2018. This tax may not exceed 25% of the income tax generated in fiscal year 2018.
  • According to the tax reform, the limit on the deduction of interest accrued on external credits that are contracted with related parties remains at the ratio 3:1 (related debt/net worth), for banks, insurance companies and entities in the popular and solidarity financial sector. For other companies and individuals, the interest on loans (from related parties) will be deductible up to 20% of the profit before employee participation, interest, depreciation and amortisation of the corresponding fiscal year. Excluded from this 20% limit is the interest for financing government-private partnership projects and public projects of common interest as defined by the competent authority.
  • Regarding digital services, the importation of such services is taxed with VAT at a 12% rate. In the case of payment for delivery services of movable goods, the taxable base will be the commission paid for the service. Credit card issuers will act as withholding agents in these cases. The regulation to the law will define the terms of application of this provision.

Answer contributed by Martín Pallares Sevilla

Get unlimited access to all Latin Lawyer content