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M&A / Private Equity Newsletter Conflict of Interests in Secondary Buyout Transactions ISSUE No 5 Applicable regulation and how to handle the risk o...
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M&A / Private Equity Newsletter

Conflict of Interests in Secondary Buyout Transactions ISSUE No 5

Applicable regulation and how to handle the risk of conflict of interest in M&A transactions involving two different PE funds

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March 2015 Brazilian FIA-MAs: a New Option for Investments in Mid-Market Companies and Private Equity A look into the regulation of the new type of fund available to both accredited and retail investors for investments in mid-market listed and unlisted companies.

p. 3

R&W Insurance: a Useful Tool for Private Equity & Venture Capital Transactions Advantages and disadvantages of the Representations and Warranties Insurance.

p. 4

Brazilian Healthcare Industry Now Open for Foreign Investment With the enactment of Law 13,097, a long-lasting ban on foreign investment in the healthcare industry has been lifted.

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Tax Advantages of Brazilian Real Estate Funds The contents of this newsletter are intended to convey general information on mergers & acquisitions and private equity in Brazil and do not necessarily express the opinion of law firm Lobo & Ibeas on the matters presented. This newsletter should not be relied upon as legal advice.

An overview on taxation of investments made through FII-Fundos de Investimento Imobiliário in the Brazilian real estate market.

p. 5

M&A / Private Equity


Conflict of Interests in Secondary Buyout Transactions


preferred vehicle for PE funds in Brazil, provides that, unless the majority at a quota-holders meeting authorizes otherwise, a FIP is not allowed to invest in securities where: (1) the FIP investment or administrative manager 1; members of the FIP investment

Last year the private equity (PE) behemoth KKR acquired the

committee; holders of quotas in the FIP representing more than 5%

Brazilian technology company Aceco TI from the PE fund

of its net worth; or their partners or spouses: (A) severally or jointly

General Atlantic and other shareholders. A sale to another

hold more than 10% of the voting shares of the issuer company; (B)

PE fund was also GP Investimentos’ exit strategy from its

are members of the board of directors, the oversight committee or

investment in the restaurant chain Fogo de Chão. Transactions

any other special committees of the issuer company; (C) are directly

like these, known as secondary buyouts, are becoming more

or indirectly involved with the issuance of such securities; or (D) are

and more common in Brazil.

the seller of these securities; or (2) the seller of such securities is another FIP run by the same administrative or investment manager.

The classic exit strategy for a PE fund is taking its invested companies public through initial public offerings (IPOs). However,

Additionally, Instrução 391 requires that documents related to

given the lingering weak performance of the Brazilian stock market

the FIP, such as prospectuses and bylaws, disclose the risk of

(IBOVESPA, which is the local main stock index, is currently at

potential conflicts of interest, and imposes on investment and

the same level it was in 2009), the environment for IPOs has been

administrative managers, as well as on committee members a

unfavorable. Thus Brazilian PE funds need to resort to different exit

duty to disclose any concrete situation of conflict of interest.

strategies. And in this strained scenario secondary buyouts are

Failure to comply with such rules exposes the wrongdoer to

proving to be a particularly good alternative.

civil and administrative responsibility.

Nevertheless, transactions where both seller and buyer are

Instrução 391 does not regulate whether quota-holders with

PE funds may trigger a question of great relevance to the PE

a conflict of interest (and committee members appointed

industry: how to deal with potential conflict of interests?

by them) are allowed to cast votes at meetings called to decide on investment strategy. There is no body of case law

Large PE management firms often manage different funds

addressing the issue. Even if the rules on conflict of interest

with diverse investment policies. There is a possibility that,

set forth in the Brazilian Corporations Act are applied by

for example, one such firm runs simultaneously a venture

analogy to FIPs – which is questionable –, doubts are not

capital fund interested in selling and an industry-consolidation

cleared, since the CVM case law on the interpretation of such

fund interested in buying the very same company. In such

rules has swung between absolute prohibition from voting and

situations, the risk of conflict of interest exists at least in

partial permission with subsequent scrutiny of the fairness of

theory, even though management firms usually appoint

transactions challenged by minority shareholders.

different individuals to lead each of their funds and the compensation scheme of these individuals encourages them

In this context, investment managers and investors should

to seek the highest possible yields for the funds they head.

consider the risk of potential conflicts in drafting/negotiating organizational documents of FIPs and in deciding whether to

Likewise, a growing number of PE funds in Brazil, especially

set up investment committees. If a concrete conflict of interest

those in which Brazilian pension funds hold equity interests

arises, immediate disclosure must follow and a quota-holders

(quotas), have set up investment committees. Such committees,

meeting held to authorize the transaction. The risk of casting

whose members are appointed by quota-holders, are generally

votes in conflict of interest situations should also be carefully

tasked with discussing and approving the manager’s investment

weighed in view of the CVM case law at the moment. And it

strategy. Therefore, secondary buyouts involving two PE funds

may also be prudent to set up a “chinese wall” and secure

in which the same individual holds investment committee seats

an independent third-party assessment of the fairness of

poses a theoretical risk of conflict of interest (that being one of

transactions carried out in situations of conflict of interest.

the numerous reasons why investment committees are not wellregarded by the international PE community). In view of the foregoing, article 36 of CVM’s Instrução 391, which

Please see Issue No 3 of our newsletter for the differences between the roles of investment and administrative managers. Available at


regulates Fundos de Investimento em Participações (FIPs), the


M&A / Private Equity



of its net worth in mid-market companies 2, (ii) imposes a

Brazilian FIA-MAs: a New Option for Investments in Mid-Market Companies and Private Equity

minimum period of 180 days for the redemption of quotas; and (iii) has at least 10 investors. Additionally, each investor (or group of related investors) must own no more than 10% of the fund’s quotas.

The CVM (the Brazilian SEC) regulated last year a new type

Despite the risk involved in the liquidity of mid-market

of investment fund: the Fundo de Ações – Mercado de

companies’ securities, the FIA-MAs may be organized

Acesso or simply FIA-MA. The declared purpose of the FIA-

either as closed-ended or open-ended funds. Instrução 549

MA is to encourage investments in mid-market companies

authorizes the FIA-MA’s administrative manager to retain the

and foster new IPOs.

services of a market maker. The market maker will buy and sell the fund’s quotas on a regular and continued basis, ensuring

According to CVM’s new Instrução 549, a FIA-MA must invest

liquidity and establishing some control over the average price

at least 2/3 of its net worth in shares issued by companies

of the fund’s quotas.

listed in stock exchange or over-the-counter market segments focused on mid-market companies and that impose additional

In FIA-MAs organized as closed-ended funds, the new

corporate governance practices in comparison to those set

regulation allows the repurchase of quotas by the fund when

forth in law. It is tailored to benefit the Bovespa Mais 1, a

they are negotiated for a price lower than their net worth value.

special over-the-counter market managed by BM&FBovespa,

The new regulation has also brought about some other

the main Brazilian exchange, currently the only listing segment

interesting rules. For instance, FIA-MA’s investment managers

in Brazil that targets mid-market companies.

are allowed to charge performance fees based on the fund’s

Where organized as closed-end funds, FIA-MAs may invest

performance in comparison to inflation or interest rate

up to 1/3 of their net worth in shares and other securities of

indices 3. The reasoning behind this rule is that stock market

unlisted companies. Prior to Instrução 549, the Fundo de

indices normally used as a gauge for performance fees do not

Investimento em Participções – FIP (also known as Brazilian

properly capture the development of mid-market companies, in

private equity fund) was the only type of fund allowed to

particular unlisted ones.

invest in unlisted companies. Similarly to a FIP, a FIA-MA must

Another important rule applies to FIA-MAs offered exclusively

have decision-making powers with respect to the unlisted

to accredited investors. In this case, the FIA-MA’s investors

companies in which it invests and such companies must

may execute partnership agreements committing to provide

follow higher corporate governance practices. The unlisted

money to the fund in the future, upon capital calls made

companies must also undergo an appraisal every year to

by the fund’s manager. The investor does not have to put

determine their fair value.

money upfront but undertakes to make the investment when

While a FIP may invest all of its net worth in unlisted

and if the fund’s investment manager finds good and viable

companies, it is only available to accredited investors

investment alternatives. This enables the FIA-MIA to operate

(financial institutions, insurance companies, investors with

similarly to a FIP and thus be used as an alternative vehicle for

large portfolios and other sophisticated investors). The

private equity investments in Brazil.

FIA-MA, on the other hand, may be offered to all kinds of investors, including non-accredited investors. It is the first Brazilian fund that allows less sophisticated investors to invest at least partially in assets negotiated in the private equity sector, opening up new investment alternatives. To make the FIA-MA more appealing, the Brazilian government

In Issue No 1 of our M&A/Private Equity Newsletter we take a look at the Bovespa Mais. A copy of Issue No 1 can be found at

enacted Law 13,043/14, establishing that if certain conditions



Law 13,043/14 sets forth which companies will be considered mid-market companies. Basically, they have to have a market value under BRL 700 million and annual gross revenues under BRL 500 million.

are met, gains obtained by individuals from the redemption of quotas of a FIA-MA are exempt from income tax. This

As a general rule, the benchmark used to calculate the performance fee in funds available to non-accredited investors has to be directly linked to the type of assets held in the fund’s portfolio.


exemption only applies if the FIA-MA (i) invests at least 67%


M&A / Private Equity



extraordinary occasions, insurance companies may also

R&W Insurance: a Useful Tool for Private Equity & Venture Capital Transactions

get briefly involved in the actual due diligence process). An underwriting fee is charged to cover related expenses. From the purchaser’s standpoint, R&W insurance offers the following advantages: (1) reduction of frictions along the

A major challenge in M&A deals is to negotiate collection devices

negotiation process (which is desirable, for instance, where

and guarantees, such as escrow accounts and security interests.

the seller will continue to do business with the purchaser);

There is a natural tension between the purchaser’s desire to obtain

(2) assurance that losses related to misrepresentations

maximum protection, and the seller’s aspiration to receive the

will be indemnified (within coverage limits), regardless of

price and cease to have responsibility for liabilities involving the

the seller’s financial condition; (3) agility in the collection

company that is being sold. Such tension is exacerbated when the

of indemnification, without the need to await the end of

seller is a private equity or venture capital (PEVC) fund, given the

strenuous litigation with the seller (and/or other guarantors);

frequent need to wind up the fund within a tight timeframe.

(4) possibility of making a more attractive buyout offer with the promise to pay the whole price or a large fraction of it upon

Largely used in the American and European markets, an

closing; and (5) better negotiating position to obtain financing

interesting alternative to overcome deadlocks over collection

for the buyout (given a lower risk of large unforeseen losses

devices and guarantees has recently been made available in Brazil

that could negatively impact cash flow).

by insurance companies: the representations and warranties (R&W) insurance. Such insurance covers losses, including litigation

From the point of view of the seller, some of the benefits of

costs, suffered by either the seller or the purchaser as a result of

R&W insurance are: (1) better bargaining position to negotiate

misrepresentations in M&A deals (provided, of course, that the

the payment of the whole price (or a large fraction of it)

insured party was not aware of the misrepresentation at the time of

upfront; and (2) reduced exposure to unforeseen expenses

execution of the relevant agreements or closing).

with the payment of indemnification.

Contingent liabilities known by the parties, even if the likelihood

The main downside of R&W insurance is its cost, which is

of a loss is low, are generally not covered. The insurer may

often higher than the expenses related to the typical collection

impose additional exclusions in view of the particularities of

devices and guarantees. However, such expenses are not the

each case. And there is often great flexibility for the insured

only cost of collection devices and guarantees: sellers generally

party to negotiate other exclusions it might be comfortable with,

accept to reduce the price of the deal where purchasers agree

which usually leads to reductions in the insurance premium (for

neither to deposit part of such price in escrow accounts nor to

example, if the seller does not have many employees and the

request extensive guarantees (which is evidence that sellers

purchaser is confident that all representations made with regard

charge a sort of fee, included in the asking price, to consent to

to compliance with labor laws are true, it may feel no need to

collection devices and guarantees). Furthermore, buyers and

insure against the risk of misrepresentations in this field).

sellers are frequently uncomfortable with insurers’ extensive degree of interference in the conduct of litigation, which limits

Although there is room for negotiation, it is trade usage to have

the insured parties’ ability to settle the dispute or to insist on

an indemnification cap between 10% to 30% of the value of the

appealing without the insurance company’s consent.

deal and to limit the period of coverage to no longer than 3 to 5 years. In most cases the premium for R&W insurance corresponds

R&W insurance works as a substitute or a supplement to

to 3% to 7% of the amount involved in the transaction, though a

collection devices and guarantees. The decision to buy

minimum fee is almost always charged regardless of the size deal,

R&W insurance instead of, or together with, an escrow

which may make it economically unfeasible for smaller cases.

account, security interests or personal guarantees involves

Preliminary quotations can be obtained by furnishing insurance

a cost-benefit analysis, which should take into consideration

companies with drafts of the relevant agreements.

the concrete aspects of each deal. The extensive use of such insurance in transactions carried out in international

To mitigate the risk of fraud and moral hazard, insurance

markets shows it is an important and efficient tool, of which

companies hardly ever provide a firm quotation without

dealmakers, investment bankers and M&A lawyers in Brazil

reviewing the purchaser’s due diligence report (and in

should be well aware.


M&A / Private Equity



Brazilian Healthcare Industry Now Open for Foreign Investment

Tax advantages of Brazilian Real Estate Investment Funds

The Brazilian healthcare industry is on the rise. Over the

The FII (Fundo de Investimento Imobiliário) is a vehicle for

past decade, millions of Brazilians have made it to the

investments in the Brazilian real estate industry. A FII may hold

middle class, consolidating Brazil as one of the largest

in its portfolio an extensive variety of assets, including real

consumer markets in the world. The increase in consumers’

property, mortgage and other real estate bonds, real estate

purchasing power, a willingness to pay for better healthcare

companies’ securities, as well as equity in other investment

services and an expanding elderly population, among other

funds. With regard to certain classes of such assets, the

factors, have prompted expectations that the Brazilian

FII, if properly structured, may provide relevant tax benefits,

healthcare industry will continue to experience substantial

especially for investors who are natural persons.

growth within the next few years, notwithstanding the slow

The FII is a flow-through entity not subject to the usual income

pace of the overall economy.

and revenue taxes applicable to Brazilian companies. At the

Until now, the healthcare industry was one of the few

investor’s level the gains obtained with the investment in a

sectors of the Brazilian economy that was not open to

FII may be subject to income tax in Brazil 1, which (as well

foreign investments. In an effort to bring more foreign

as the applicable rate) will depend on (i) how the gains were

investments to Brazil, the Brazilian government has lifted

obtained, (ii) whether the investor is a natural or legal entity,

this longstanding ban.

and (iii) where the investor is resident, domiciled or set up.

On January 19, 2015 Federal Law 13,097 was enacted

Gains arising from distribution of proceeds, as well as

to expressly authorize foreigners to acquire, directly or

amortization or redemption 2 of quotas will be taxed as follows:

indirectly, equity interests, including controlling ones, in

(1) natural persons, whether resident or domiciled in Brazil or

legal entities carrying out the following activities in Brazil:

abroad: are exempted from income tax, provided that (a) the

(1) running hospitals, clinics and laboratories; (2) production

FII quotas are traded exclusively in exchanges, (b) such quotas

and distribution of medicines and other health products; (3)

are held at least by 50 different investors, and (c) the investor

research and services related to human genetics; (4) clinical

that intends to benefit from the exemption neither holds more

analysis, diagnostic imaging and analysis of anatomical

than 10% of the FII quotas nor is entitled to more than 10% of

pathology; and (5) family planning.

the FII’s proceeds; and (2) legal entities and natural persons not exempted: are subject to income tax at a fixed rate of 20%, if

This is good news for the international private equity & venture

the investor is resident, domiciled or set up in Brazil, and 15%,

capital community, which now has a new open field for

if the investor is resident, domiciled or set up abroad, of the

investments in Brazil, with encouraging prospects of returns.

proceeds distributed (in case of amortization or redemption, though, only the investor’s net gain is taxed). Such tax, where applicable, will be levied at the moment the FII transfers profits to investors. The FII’s administrative manager must withhold and pay on investors’ behalf the amount due. It is noteworthy that FIIs must transfer to investors at least 95% of their profits recognized in each semester on a cash-basis accounting system (in accordance with financial statements dated as of June 30 and December 31). Such a rule is targeted at avoiding that profits remain untaxed indefinitely. Direct distribution of dividends by invested companies to the FIII’s investors is exempted from income tax. On the other hand, direct payment of interests on net equity (juros sobre o


M&A / Private Equity



capital próprio) by invested companies to the FII’s investors is

in distribution of proceeds, as well as redemption, amortization

subject to withholding income tax at a fixed rate of 15%. Such

and sale of quotas. Dividends paid to tax-haven domiciled and

rules apply to all investors, whether natural persons or legal

“privileged tax regime” foreign investors are – as usual – exempt

entities, or resident, domiciled or set up in Brazil or abroad.

from income tax. Interests paid on net equity for those investors,

Additionally, PIS and COFINS will be levied on direct payment

on the other hand, are subject to a 25% (rather than the normal

of interest on net equity made to legal entities set up in Brazil.

15%) withholding income tax.

FIIs’ income and investors’ gains arising from distribution of

Notwithstanding its flow-through entity status, gains obtained

proceeds, as well as amortization or redemption of quotas

by the FII with investments in financial instruments other

are not subject to PIS and COFINS, which are generally levied

than mortgage and real estate bonds are subject to the

on the income of real estate companies set up in Brazil (as a

same income tax regime generally applicable to financial

rule, natural persons and legal entities set up abroad are not

investments in Brazil 5. However, such tax may be offset

subject to PIS and COFINS).

against the income tax due at the moment the FII transfer such gains to investors. Gains arising from investments in

As to sales of quotas to third parties, gains will be taxed as

mortgage and real estate bonds are exempt from income tax.

follows: (1) if the investor is resident, domiciled or set up in Brazil, at a fixed rate of 20% of the investors’ total net gain within the

The FII will lose its flow-through entity status if it invests

respective month of all transactions involving quotas of FIIs

in ventures where the developer, the constructor or other

(however, if the investor is a natural person and the transaction

investor is also an investor of the FII who holds, either severely

does not occur in an exchange, the 20% rate will be calculated

or jointly with related persons 6, more than 25% of the FII

on the capital gain of each separate transaction); and (2) if the

quotas. In such case, the FII will be subject to the same tax

investor is resident, domiciled or set up abroad, whether a natural

regime applicable to Brazilian companies. The goal of such

person or legal entity, transactions (a) executed in exchanges will

a rule is to discourage real estate companies from benefiting

be tax free, and (b) transactions carried out outside exchanges

from tax advantages granted to FIIs in ventures where there is

will be taxed at a fixed rate of 15% of the investors’ total net gain

no or small investments from third parties.

with all transactions involving quotas of FIIs within the respective

Given all its peculiarities, the FII is not always the most suitable

month. The income tax due in quota sales, where applicable,

vehicle for private equity investments in the Brazilian real estate

must be paid directly by the selling investor.

industry, although under certain circumstances it may offer

In any scenario, if the investor is resident or domiciled in Brazil

material tax advantages if properly structured. Hence, before

and a natural person, the income tax withheld or paid is final

resorting to the FII it is important to carefully consider whether

and no additional amount is due to the Brazilian IRS. If the

other investment vehicles would not be more tax-efficient.

investor is a legal entity set up in Brazil, the realized gains, as well as the corresponding tax withheld and paid, will be taken This article deals only with taxation in Brazil. It does not address the foreign taxation of gains obtained by investors with their investments in a FII.


into account for the calculation of the investor’s total taxable profit, and additional payment of income tax may be necessary,


along with social contribution on net profits, PIS and COFINS 3.

Which may only occur when the term of the fund expires or upon dissolution of the FII.

3 The

additional tax due, if any, will depend on the tax regime adopted by the investor in Brazil.

Additionally, FIIs’ investors may also be subject to a financial

Instrução 1,037/2010 of the Brazilian IRS lists the jurisdictions considered to be tax havens and the business entity types that are considered to have a privileged tax regime (for example, the Uruguaian Sociedades Anónimas Financieras de Inversión).


transaction tax (IOF) under the categories “Securities” and “Money Exchange”. However, the current rates applicable to transactions related to FIIs are zero.

Unless such financial instruments are subject to a special tax regime, the applicable income tax will vary according to the time period elapsed between the investment date and the date of recognition of gains, as follows: (i) up to 180 days: 22.5%; (ii) from 181 up to 360 days: 20%; (iii) from 361 up to 720 days: 17.5%; and (iv) for more than 720 days: 15%.


Specific rules apply to investors domiciled outside Brazil in jurisdictions that do not impose any income tax or charge income tax at a rate lower than 20% (frequently referred to as tax havens)

For this purpose, a related investor means (i) with regard to a natural person, her/his close relatives (parents, children, grandparents, grandchildren and siblings), legal entities controlled by such investor or by any of his/her close relatives, and partners, directors or officers of a legal entity under the control of such investor or his/her close relatives; (ii) with regard to a legal entitiy, its controlling shareholder, controlled companies and affiliates.


or that are organized under a business entity type considered to have a privileged tax regime 4. Such investors are subject to the same tax treatment applicable to individuals resident in Brazil


Editorial Team C.A. da Silveira Lobo Manoel Vargas Franco Netto Joaquim Simões Barbosa Pedro Paulo Salles Cristofaro Renata Novotny Natalie Sequerra Paulo Eduardo Penna Guilherme Leporace Juliana Zielinsky Yonenaga Bruno Haack Vilar Ana Carolina Pimentel Juliana Carvalho de Azevedo

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