Legal Due Diligence in Brazil: What Foreign Investors Should Review Before Investing in a Company
Becoming an equityholder of an existing operating company, whether through an acquisition, an investment, a joint venture or other types of corporate transactions, is a common structure to start doing business in Brazil.
Carrying out a legal due diligence to identify existing and potential liabilities and legal risks and confirming ownership of assets is particularly important before closing a deal involving a Brazilian company.
The importance lies not only in having the right information to determine the right price to be paid or investment to be made, but also in confirming the target company’s conditions and ability to carry out the business intended by the foreign investor, as well as in providing better insights for contractual protections, including representations and warranties and indemnification.
In this context, proper legal due diligence usually precedes the conclusion of the transaction, especially with respect to (i) corporate aspects (ownership and corporate governance), (ii) tax, labor and civil contingencies, (iii) real property use and ownership, (iv) intellectual property use and ownership, (v) material contracts and (vi) licenses, authorizations, permits and regulatory matters.
This article outlines the legal due diligence process in Brazil, focused on the aspects mentioned above.
Corporate Aspects
Businesses in Brazil are usually incorporated as limited liability companies (sociedades limitadas) or corporations (sociedades anônimas) (for further information on these types of legal entities, please refer to our article Types of Company in Brazil).
The ownership of quotas (in limited liability companies) is recorded in the company’s articles of association and the ownership of shares (in corporations) is recorded in the company’s share registry book. Reviewing such documents, therefore, is essential to confirm who owns equity in the target company – and, therefore, the parties with whom the deal should be negotiated.
The review of the articles of association and partners agreements (with respect to limited liability companies) and bylaws and shareholders agreements (with respect to corporations) is equally important to understand the target company’s corporate governance, as well as any third-party rights associated with the transfer of equity (rights of first refusal, rights of first offer, preemptive rights, tag along rights and drag along rights).
The review of corporate aspects in a legal due diligence will allow the investor to (i) confirm the identity of the owner of the target company’s equity subject to the transaction (and, therefore, the person who needs to be formally bound under the relevant contracts), (ii) identify third-party rights that need to be addressed before the deal can be closed (including by obtaining waivers and/or processing rights of first refusal, rights of first offer, preemptive rights, tag along rights and drag along rights) and (iii) identify corporate governance rules that need to be changed once the deal is closed.
Tax, Labor and Civil Contingencies
Brazilian courts issue certificates in which ongoing judicial proceedings involving a given person are shown.
Brazilian tax authorities also issue certificates showing the existence of administrative tax proceedings and tax debt involving a given person.
In order to map out existing tax, labor and civil judicial and administrative proceedings, as well as existing tax debt, the legal due diligence includes the review of such certificates.
Based on the certificates, further documents and information may be reviewed, including the files of the applicable judicial and administrative proceedings, additional reports issued by tax authorities and reports prepared by the lawyers representing the target company in the identified proceedings.
The legal due diligence also includes assessing practices and/or actions of the target company that, although not reflected in an existing judicial or administrative proceeding, may result in tax, labor or civil contingencies.
Real Property Use and Ownership
The ownership of and liens on real property in Brazil are recorded in real estate registry records (matrículas) registered with real estate registry offices.
The legal due diligence includes reviewing the deeds of all real properties owned by the target company with the purpose of confirming the ownership thereof and any liens thereon.
In cases in which the target company uses real properties owned by third parties, the review would typically include the real properties deeds (in order to confirm the identity of the owner) and the lease agreement executed with the owner of the property.
To the extent a real property is not owned by the target company and is vital to its business, confirming the term of the respective lease agreement becomes of high importance (as well as securing longer terms as part of the transaction, as applicable).
It is important to note that the ownership and use of rural real properties by Brazilian entities controlled by foreign companies may be subject to restrictions (such restrictions are higher with respect to rural real properties within the so-called “border areas”).
Intellectual Property Use and Ownership
The ownership of intellectual property such as trademarks and patents is registered with the Brazilian National Institute of Industrial Property (Instituto Nacional da Propriedade Industrial – INPI).
The review of the applicable registries with the INPI is carried out as part of the intellectual property legal due diligence.
The analysis of such registries and, as applicable, their underlying administrative proceedings, allows the identification of the intellectual property’s owner and any existing oppositions.
In cases in which the target company uses intellectual property owned by third parties, the legal due diligence would typically include the confirmation of the identity of the owner of the intellectual property and the review of the relevant intellectual property license agreement executed with the owner of the intellectual property.
Copyrights, although protected by Brazilian copyright law, are not required to be registered (although registration may be sought with certain entities, such as the National Library).
Material Contracts
A legal due diligence would typically include the review of material contracts to which the target company is bound. The materiality is determined based on the particulars of the transaction (type of industry, size of the company, size of the investment, etc.) and usually takes into consideration amounts involved, term, strategic aspects and types of contracts.
Examples of material contracts include agreements with strategic suppliers, agreements with strategic clients, financing agreements, security interest agreements, strategic real properties lease agreements and strategic machinery or assets lease agreements.
Identifying the term of material contracts, as well as termination clauses (especially in connection with change of control), is particularly relevant for this part of the legal due diligence.
Licenses, Authorizations, Permits and Regulatory Matters
Companies need to obtain certain licenses, authorizations and permits to operate in Brazil. The type of licenses, authorizations and permits will depend on the type of activities carried out by the company.
Examples of such licenses, authorizations and permits include those issued by the fire department, municipal authorities, sanitary vigilance authorities, environmental authorities, among other governmental authorities.
Certain industries are subject to specific regulations and companies operating in such industries may be required to obtain additional licenses, authorizations and permits, as well as comply with particular rules. Regulated industries include those of financial institutions, insurance, oil and gas, aircrafts, online gaming (while permitted by law), food and beverages, pharmaceutical, among others.
Verifying if the target company holds all applicable licenses, authorizations and permits is part of the legal due diligence and allows the foreign investor to identify if the target company is duly authorized to operate.
How Due Diligence Findings Affect the Transaction
The legal due diligence findings have an important role in the negotiation of the transaction and its respective contracts and documents.
Among other purposes, the legal due diligence findings are relevant in the following aspects of the transaction:
- identified contingencies and liabilities may affect the acquisition price and/or be reflected in contractual arrangements on price adjustment, price holdback, escrow account, representations and warranties and indemnifications;
- identifying actions that need to be set as conditions precedent to the closing of the transaction (including remedying practices that are non-compliant with the law);
- identifying corporate governance rules that need to be changed and/or addressed on a shareholders agreement or partners agreement; and
- identifying practices or policies that need to be terminated or changed after the transaction is closed.
MMR – Mastrocola Marcondes Rocha Advogados has solid experience with assisting foreign clients with legal due diligences in Brazil. Over the years, we have carried out legal due diligences of companies active in several industries, contributing to the successful negotiation and drafting of transaction documents in mergers and acquisitions, joint ventures and corporate transactions in general. Please reach out to us to understand how we may assist you with the legal due diligence of a company in Brazil.