The dilemma faced by merging companies vis-à-vis gun jumping risks in Brazil
May 2017 | EXPERT BRIEFING | MERGERS & ACQUISITONS
The 2011 Brazilian Competition Act came into force five years ago, and during the initial period of implementation of the pre-merger control system in Brazil, some important lessons were learned in relation to the measures and conduct that companies doing business in Brazil should avoid before getting their deals approved by the Administrative Council for Economic Defence (CADE).
Pre-merger control system and gun jumping issues: general rules
The Competition Act sets forth that a given transaction constitutes market concentration and, as such, may be subject to pre-merger review when: (i) there is a merger between two or more previously independent companies; (ii) there is a direct or indirect acquisition, by one or more companies, of control or parts of one or more companies, through the purchase or leasing of shares, membership units, convertible securities, tangible or intangible assets or by means of any kind of agreement; (iii) one or more companies absorb another company or companies; and (iv) two or more companies enter into an associative agreement, consortium or joint venture.
Such transactions must be notified to CADE for approval whenever they meet the following cumulative financial thresholds: (i) at least one of the economic groups involved in the transaction registered gross revenues or volume of businesses in Brazil equal to or exceeding BRL750m in the fiscal year preceding the transaction; and (ii) at least one of the other economic groups involved in the transaction registered gross revenues or volume of businesses in Brazil, equal to or in excess of BRL75m in the fiscal year preceding the transaction.
Transactions that are subject to mandatory filing with CADE cannot be consummated until the authorities render a final decision, on pain of breaching the law and engaging in so-called ‘gun jumping’. CADE’s internal regulations establish that the parties to a reportable transaction must keep the physical structures and competitive conditions unchanged until CADE’s final decision. They also prohibit transfers of assets or any influence of one of the deal parties over the other, as well as any exchange of competition-sensitive information not strictly necessary for executing the formal binding instrument between the parties.
Penalties for gun jumping in Brazil comprise fines ranging from BRL60,000 to BRL60m, in addition to possible annulment of any acts performed by the parties before obtaining CADE´s approval and commencement of an administrative investigation into potential anticompetitive conduct.
In light of the broad terms of the rules introduced in 2012, considering the peculiarities of companies’ needs when doing business in Brazil, and also due to the uncertainty around notifying some transactions that were not reportable in the previous regime, CADE has had to deal with considerable gun jumping issues.
From 2013 to 2015, CADE’s general superintendent identified gun jumping issues in five cases and decided to enter into settlement agreements with the companies involved. Under these settlement agreements, the companies decided to pay contributions to CADE, after acknowledging that they had taken measures that were not permitted before obtaining CADE’s approval for their deals.
In May 2015, CADE launched guidelines laying down specific rules to prevent gun jumping practices. The gun jumping guidelines divide activities that may raise certain concerns into (i) exchange of sensitive information; (ii) definition of contractual clauses that govern the relationship between market players; and (iii) activities carried out by the parties before and during the implementation of concentration transactions.
Accordingly, competitively sensitive information relates to specific data about costs, capacity level and expansion plans, marketing strategies, product pricing (prices and discounts), main customers and secured discounts, payroll, main suppliers and contractual terms and conditions of supply, non-public information about trademarks, patents and research and development, future acquisition plans and competitive strategies.
Contractual provisions that may lead to gun jumping issues, as provided by the guidelines, include: (i) full or partial advance payment of non-reimbursable consideration (except for typical down payments in business transactions, deposits in escrow accounts or clauses dealing with break-up fees); (ii) clauses establishing that the contract effective date precedes its closing, implying some interaction between the parties; (iii) prior non-compete obligations; (iv) clauses providing for the direct influence of one party over the strategic and sensitive business aspects of the other (such as prices, clients, commercial policies and other aspects that do not reflect a mere protection of the investment); and (v) any clauses establishing activities that cannot be reversed at a later time or whose reversal would require significant expenditure.
As for activities performed by the parties before prior clearance by CADE, the gun jumping guidelines mention the receipt of profits or other payments related to the other party’s performance (earn-outs), transfer and usufruct of assets in general (including voting securities), exercise of voting rights or relevant influence over the other party’s activities, the development of joint sale or marketing strategies for products, characterising joint management, the integration of a sales force, exclusive licensing of intellectual property to the other party, joint development of products, nomination of members for decision-making bodies and the interruption of investments.
Selected cases involving gun jumping
After the gun jumping guidelines were released in 2015, and clearer recommendations for parties involved in a transaction were put in place, CADE ruled on three concentration transactions that are worth discussing, since they provide additional clarification about the authorities’ approach.
Regarding the acquisition of Hypermarcas’ Brazilian condoms and lubricants business by Reckitt, CADE’s tribunal ruled that the 20 percent down payment made by Reckitt was typical of businesses transactions and was proportional in that specific case, thus falling into an exception provided by the gun jumping guidelines. The reporting commissioner on the case mentioned that CADE should not establish a fixed amount for down payments, on the grounds that each case has its own specificities. In addition, CADE’s tribunal concluded that down payments and break-up fees could coexist in the same agreement and even compensate each other if the transaction under analysis was eventually rejected.
The acquisition of Cisco’s customer premises equipment (CPE) business by Technicolor was globally consummated without CADE’s approval. The parties did inform CADE about the closing, arguing the urgent need to implement the deal and the lack of negative impact on the Brazilian market. CADE’s tribunal held that most competition agencies worldwide are reluctant to accept carve-out agreements to exclude or even mitigate gun jumping practices, considering the uncertainty of their effectiveness (especially regarding difficulties with controlling or impeding the exchange of sensitive information). A settlement was then negotiated between CADE’s tribunal and the parties, ultimately resulting in the highest financial contribution in the context of gun jumping practices so far, BRL30m.
The Blue Cycle and Shimano deal concerned the formation of a joint venture for the exclusive distribution of Shimano’s cycling products in Brazil. CADE’s tribunal, for the first time, applied the annulment provision envisaged in the Brazilian Competition Act. Even though the transaction itself was not voided, CADE’s tribunal imposed the sanction on the supply agreement associated with the joint venture until a final decision on the merits was ultimately issued.
Important dos and don’ts prior to gaining clearance from CADE
Following the criteria reflected by the gun jumping guidelines, there are three main phases that should receive more attention by parties to avoid possible gun jumping infringements. First, negotiations preceding the deal. During this phase it is important to ensure that any sensitive information exchanged by the parties is carefully evaluated and a protocol used to prevent possible misuse. Second, drafting contracts. During this phase, in addition to the exchange of information issue, the parties should ensure that clauses are written in such a way that no interference between them is allowed until CADE’s clearance. Finally, after signing and before clearance. During this phase, and also in addition to the exchange of information issue, the parties should maintain their ordinary course of business without one party exerting influence over another.
In the five years since the 2011 Brazilian Competition Act came into effect, CADE has gone a long way in its efforts to identify what would constitute gun jumping and, thus, dispel the overall feeling of uncertainty experienced by parties to a deal.
Cristianne Saccab Zarzur and Leonardo Rocha e Silva are partners and Marcos Pajolla Garrido is an associate at Pinheiro Neto Advogados. Ms Zarzur can be contacted on +55 11 3247 8631 or by email: email@example.com. Mr Silva can be contacted on +55 61 3312 9488 or by email: firstname.lastname@example.org. Mr Garrido can be contacted on +55 11 3247 6258 or by email: email@example.com.
© Financier Worldwide
Cristianne Saccab Zarzur, Leonardo Rocha e Silva and Marcos Pajolla Garrido
Pinheiro Neto Advogados