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Due Diligence for Acquisitions in Mexico - Selected Issues

Luis Armendariz

Due Diligence for Acquisitions in Mexico - Selected Issues

In the context of mergers and acquisitions, domestic or cross-border, due diligence is an essential component and an indispensable requirement for any such transactions to even gain traction in the early stages.  The investigation of a target company’s structure, operations and condition on various fronts is an exercise that every advisor or consultant to a buyer will recommend.  Generally speaking, the purpose of due diligence is to prevent any risks that can disrupt the deal, or that might have financial, reputational or operational impact once the acquisition is closed, such be the case.  The findings and conclusions often become determinant factors in the outcome of a transaction, be it the deal falling apart or a successful closing paving the way for a new stage of the business.   

While the above is now legal common sense to any corporate transactional legal advisor, it becomes necessary at times to add an additional layer of complexity when dealing in the context of cross-border transactions.  The degree of complexity varies depending on the number of jurisdictions involved and whether such jurisdictions can be referred to as ‘investor-friendly’, among other factors.  In this article, we address a selection of relevant considerations when due diligence is performed on a target company located in Mexico.  

1. Understanding Particularities of Mexican Law.

Regardless of the type and scope of the due diligence, clients contemplating an acquisition should keep in mind the legal framework that applies to any potential transaction in order to obtain as many data as possible. 

The Mexican legal system derives from the civil law tradition.  All laws are written in the form of main laws, codes and various types of secondary rules and regulations.  Along the same lines, all permits, authorizations, licenses and legally binding contracts and agreements must be in writing.  Therefore, a data room for a legal due diligence review should contain any relevant documents and information in written form.

Secondly, there are specific areas of law that warrant special attention due to the potential for increased risk from a buyer’s perspective, namely:

a) Labor Law: Mexican labor law is heavily pro-worker.  For most cases, burden of proof rests with the employer and, in practice, the majority of employee claims are finalized through a settlement rather than awaiting a final resolution.  It is critical to review compliance with legal obligations imposed on employers.  A sample of required information for labor and employment due diligence would include an inventory and copies of the written, executed, individual employment agreements, collective bargaining agreements, registration of the company with the Mexican Institute of Social Security and with the National Institute for Workers Housing Fund, among others.

b) Real Estate: Land ownership in Mexico is divided into two types: private property (traditional fee simple for private parties, individuals or entities) and an agrarian form of ownership created by the Mexican post-revolution regime called ‘Ejido’.  A substantial portion of the country is owned by Ejidos, which are local communities with governing bodies and internal regulations subject to Agrarian Law.  A real estate section of a due diligence request list would include (i) for private property, title deeds for the land and buildings owned by the company and its subsidiaries, registered liens or lease agreements, and any applicable governmental permits; or (ii) or in the event of Ejido land, the documents that support a private party’s right of possession through any given agreement, and the documents that evidence the legal authority of the Ejido representatives to enter into such agreements.  Please note that in any case, local support will be, depending on the location, sometimes needed in order to appear at state public registries.

c) Foreign Trade and Tax: Mexico’s attractiveness includes the significant number of available free trade treaties (including the United States-Mexico-Canada Agreement, or USMCA) and its geographical location.  Therefore, especially in the manufacturing industry, government incentives and programs to foster industrial activity are key factors that lead to interest in Mexican target companies (stock or assets).  In-bond programs, such as maquiladora or mechanisms, to facilitate better cash flow availability through value added tax certifications play a critical role.  In order to keep these benefits available, compliance with general tax obligations has become a requirement subject to permanent review.  A review on this area should, among others, include tax returns, any authorization granted by tax authorities, and temporary import permits for equipment and raw materials.

d) Litigation: Litigation in Mexico has been traditionally long and often times expensive.  Although significant steps have been taken to make judicial dispute resolution more efficient, the existence of potential contingencies and liabilities is always a possibility.  These risks must be properly identified and reviewed by a litigation specialist in order to be able to allocate a meaningful value to it.  This section of the due diligence request list should include a list of lawsuits and other administrative (i.e., from or against government agencies) legal proceedings, constitutional lawsuits or injunctions (amparos), or any other judicial, arbitration or administrative procedure involving the company or its subsidiaries.

The issues discussed above are not intended to imply that the due diligence review on other aspects of a company’s legal lifecycle is less important.  It is merely intended to highlight those components of the general process that may deserve special attention in Mexico.  For example, organizational and corporate record-keeping is mandated by law but it is common to encounter private companies (especially if they’re still family controlled or not publicly listed) with a low level of compliance.  Also, the legal framework in areas such as data privacy, antitrust, anti-corruption and environmental has been evolving and broadening.

2. Selecting a Local Team.

In a general due diligence exercise, the buyer needs to work closely with advisors.  Typically, a team of advisors is led by corporate lawyers, but financial advisors, accountants, tax experts, and in some instances business-specific technical advisors are also required to oversee operational changes.  When putting the team together, it is often beneficial to consider engaging local legal counsel who have experience navigating the local business environment as it applies to the relevant transaction at hand: (a) geographically, knowing the country area or region where the target company is located, to the extent it is deemed relevant; (b) politically, understanding that ‘all politics are local’, be it at a federal or local level; and (c) legally, mastering not only the applicable legal framework to the target’s business activities, but also the manner in which relevant government agencies work.

3. Seller Profile; Business Culture.

For a variety of reasons, public financing in Mexico is much less accessible than in other jurisdictions.  The number of Mexican companies listed in any of the two stock exchanges is significantly lower compared to other countries, which results in most businesses being privately owned.  Such private companies will often be family owned and operated structures, or business operations with a low level of due diligence in their corporate record keeping and financial reporting practices.  This can likely result in actions required to be taken prior to closing, or, occasionally, conditions precedent to be complied with after the deal is closed. 

Considering the foregoing, it will be helpful to make an assessment on the seller’s business level of sophistication, so expectations can be set and managed properly for the deal process.

While a legal due diligence is commonly performed, whenever possible, we recommend performing an operational due diligence which oftentimes sheds light on many issues or practices that are not mentioned in any document or registry.

4. Country Risk; Industry Risk.

The country’s current Administration has taken actions seen by the international business community as a step back in building the nation’s economic development through foreign and domestic investment.  These actions include enactment of new laws or amendments to existing ones, orders and decrees aimed at times at foreign companies.  In other cases, the actions have been directed at specific players in industry sectors that are deemed to be of strategic importance to the country or to the industry in general, such as mining, renewable energy, infrastructure, power generation and fuels.  Mexico’s current President has also increased in an unprecedented fashion the involvement and authority of military bodies in areas such as customs and ports of entry operation, sanitary control agencies or highways and ports oversight, among others.  Although a presidential election will take place in summer of 2024, it is still important to keep the country’s current situation in mind and determine, in consultation with your local team, any potential risks or impact that the due diligence review may reveal.

In conclusion, a traditional due diligence exercise in mergers and acquisitions typically follows the practice and standards used in the United States or the United Kingdom.  However, as discussed above, it is important to recognize and keep the nuances that other jurisdictions may have in mind.  This awareness will derive in a better planning and organization of the due diligence review process, and lead to the expected results and achievement of the bottom-line due diligence purpose.