As the economic relationship between the United States and Mexico has continued to grow and mature, our two countries' economies have become increasingly integrated. Nowhere is this more evident than in the number of companies operating on both sides of the border and in the increased economic cooperation between U.S. and Mexican companies and entrepreneurs. This cooperation may take many forms, from simply investing in previously existing companies, to forming new joint ventures, to merging with or acquiring a target company on the other side of the border. While many of the economic and legal fundamentals inherent in such transactions remain the same whether the transaction is domestic or international in nature, there are nonetheless unique issues and concerns that must be addressed in cross border transactions.
Transactions with Mexican Partners:
Setting Up the Deal
A successful business venture involving parties from both sides of the border requires serious forethought on both the legal and business fronts. The parties must consider the assets each brings to the table, the best way to optimize those assets and the best way to limit or mitigate any risk factors. In a merger or joint venture, the partners must decide such basics as who will have day-to-day management or decision-making authority to bind the company; which decisions require unanimous or super-majority consent due to their importance; under what circumstances a party may exit the joint venture, selling their interest to a third party; under what circumstances a party may be forced out of the business through a buy-out provision; what happens when the parties become deadlocked on decisions of vital importance to the business; what happens when the business requires additional capital and one party is not willing or able to make a new capital contribution, etc.
Going through the exercise of asking these questions and working out agreeable solutions will ultimately result in a document to memorialize the relationship of the parties. In the United States, this would typically take the form of a shareholders or similar agreement. However, it is important to note that the use of such documents in the Mexican context should be approached with caution, as certain typical provisions may run afoul of Mexican law and be unenforceable. For this reason, it is vital that the parties avoid the wholesale transfer of U.S. style documents to the Mexican arena. While U.S. parties may feel more comfortable with their standard documents and legal structure, these must be reviewed by attorneys licensed to practice Mexican law in order to ensure their enforceability. Many of the goals set out under U.S.-style documents must be structured differently in the Mexican system in order to ensure enforceability. For example, due to a general prohibition under Mexican law, shareholders are not permitted to agree beforehand how they will vote their shares. This would undermine the enforceability of many provisions under the typical U.S shareholders' agreement. However, in Mexico, if properly structured as part of the articles of incorporation and bylaws, many of the same goals and objectives may be achieved.
Acquisition of Shares or Assets
In the case of an acquisition, whether it be of shares or assets, the necessary due diligence will be much the same as with a domestic transaction. There will, however, be certain key differences to be aware of. First and foremost will be the legal and regulatory framework within which the business operates and within which the assets are held. Mexico has unique rules regarding the participation of foreign ownership in certain industries. Notable examples include: the petroleum and electricity generating industries, which are generally limited to government participation; land passenger transportation services and radio and television transmission (except cable television), which are reserved for Mexicans; the domestic airline industry, which allows a maximum 25% foreign participation; and the insurance industry, which allows a maximum 49% foreign participation, just to name a few. In addition, foreign participation may require government notification and, in certain circumstances, approval.
Other differences to be aware of include the threshold and approval process for certain transactions that are subject to anti-trust scrutiny, as well as restrictions involving foreign ownership of real property located in the coastal and border regions. In addition, many other practices vary. Notable examples include: i) regulatory oversight and environmental controls and restrictions, which vary significantly from their U.S. counterparts; ii) the role of the notary public in Mexico's civil law system. The Mexican notary public is a lawyer empowered by the state to vest the documents he or she "notarizes" with presumed authenticity, truth and enforceability. He is also charged with the correct calculation and payment of taxes generated by these transactions; iii) the role, duty and standards of professionals such lawyers, accountants and brokers, which are not regulated to the same extent as their U.S. counterparts; iv) the use of escrow arrangements for facilitating transaction closing and post-closing matters, which is not commonly used in Mexico; and iv) the extent and use of insurance, such as title insurance, which is not as extensively used in Mexico as in the United States.
Specific Business Considerations
There are a number of situations peculiar to doing business in Mexico. Following is a brief description of some of the most relevant:
Restrictions on Foreign Investment
Briefly discussed above, depending upon the type of business to be engaged in, there may be restrictions either limiting the amount of foreign capital permitted to participate in a certain venture, or barring foreign capital altogether.
The low wages prevalent in Mexico have been a motivating factor in much foreign direct investment. Nonetheless, investors should be aware that Mexico's labor law system is much more employee oriented than its U.S. counterpart. Employment in Mexico is not generally considered "at will." This means that employees may only be fired for those causes specifically enumerated in the federal labor law statute, or by payment of a statutorily calculated severance payment. In addition, there are a number of other differences from the U.S. system, including mandatory profit sharing, annual holiday and seniority bonuses, minimum vacation and rest days, and more. There are, however, mechanisms commonly used to manage the risk inherent in some of these items. For example, exposure to profit sharing is commonly mitigated through the use of "service companies" that provide the employees to the income-generating entity. These must be carefully structured, however, in order to be deemed sufficiently independent and therefore legitimate. Similarly, "friendly" unions are often employed to provide a buffer against assaults by more aggressive unions.
Form of Entity
Mexican law provides for a number of types of entities, some of which match up better than others with particular U.S. investors' needs. The most common type of Mexican business entity is the sociedad anónima de capital variable or S.A. de C.V. This is most similar to the U.S. corporate form. Another type of entity often preferred by U.S. investors is the sociedad de responsabilidad limitada de capital variable or S. de R.L. de C.V., which is most comparable to a U.S. limited liability company, or LLC and is given "flow through" tax treatment for U.S. income tax purposes. In addition, Mexican law provides for a number of other types of entities, most of which are used only rarely.
The most important taxes in Mexico include the federal income tax (impuesto sobre la renta), the value added tax (impuesto al valor agregado), the single rate business tax (impuesto empresarial a tasa única), and state taxes including the real estate tax (predial) and the real property transfer tax (impuesto sobre adquisición de bienes inmuebles). While the overall tax burden is comparable to that generally prevailing in the United States, U.S. investors doing business in Mexico will require expert tax advice from the outset in order to choose the most appropriate type of Mexican business entity for their particular U.S. tax situation, and make adequate use of the provisions of the U.S.-Mexico tax treaty in order to avoid being subjected to "double taxation."
Cross border mergers and acquisitions transactions between the United States and Mexico now occur on a regular basis. Given the differences that exist between the legal systems and business customs between the two countries it is essential that U.S. parties to such transactions avoid the temptation to transfer wholesale the documents and structures they may have become used to in the domestic arena. It is highly advisable to rely on counsel licensed to practice in Mexico to advise on the proper Mexican documents and structures necessary to achieve the parties' objectives.
Mr. Herrera is a member (partner) with the law firm of Jennings, Strouss & Salmon where he practices corporate law with an emphasis on Mexico-related mergers, acquisitions, joint ventures and resort development. Mr. Herrera is licensed in both Mexico and the U.S.