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Brazil’s ‘Turmoil period’

South America’s largest country must emerge from its recession years and come up with sound economic policies to once more gain the trust of the international M&A community, writes Thiago Barbosa Sandim of Demarest Avogados

Please give us an overview of the current legal market in Brazil and how any recent developments have impacted your practice?

I would say the legal market is showing surprising levels of resilience and growth for a country in such a turmoil for such a long per

iod. The compound annual growth rate of our practice for the last four years ending in December 2017 puts us at a healthy positive two figure number.

That looks awesome by developed markets standards, but the Brazilian legal market could have done much better if it wasn’t for the size of the Brazilian government vis-à-vis the Brazilian economy (some studies put the government spending at 40 per cent of the internal gross product) and related impacts.

In a nutshell, given such relative size of the government, any disruption at the federal level automatically impacts business. There were plenty of disruptions during the last three to four years. From the impeachment of the former Labor party government, to the bribery scandals potentially involving the current government and, finally, the impending general elections in October 2018. Let’s call this the ‘Turmoil Period’.

Political facts and their consequences in the economy during this period most definitely affected the rhythm and number of M&A deals, as well as the high end legal industry. Industry wise, large chunks of very competent lawyers split from traditional firms and formed new competition as there was no room for up-and-coming individuals to join the partner ranks. We stayed largely at bay and did not lose relevant partners for the competition, but we do recognise there are new competitors which must be watched.

It also became clear during the Turmoil Period that there are two different types of M&A practice in the country – one focusing on the so-called middle market and the other on high-end deals.

The middle market practice continued to be strong during the Turmoil Period.
A $2 trillion dollar such as Brazil obviously encompasses an internal market which is strong enough to create deal feedback and demand enough to keep the growth at a steady pace, even in a recessive market (which was our case in 2015 and 2016 – the longest and deepest recession occurring in Brazil for 120 years).

The high-end deals, however, went through a roller-coaster drive for the past three years. Very big deals were negotiated. Many of them went through, but a significant number did not for a very simple reason – the seller was the government and the government was in a huge turmoil, without a clear drive, or having a very difficult time to approve the sale of its assets. Good examples are the Petrobrás divestment program (materialised only partially), the privatisation of the Eletrobrás system (only marginally materialised), and the privatisation programme designed by the current federal government early
on its term and never completed.

Another development worth of note is related to anticorruption. The Brazilian federal police and the public prosecutors’ office (ministério público federal) have uncovered a series of corruption scandals in some of the most important Brazilian conglomerates. There are very weak or non-existent compliance controls in many of the big players of the Brazilian market. This fact significantly changed the way foreign buyers approach M&A deals in Brazil.

For the most part, compliance and anti-corruption, which were mere support areas in a wide due diligence practice in the past, became core areas. Law firms created practices which rapidly became a very important source of revenues. More important than that, a very relevant part of the M&A negotiations now focuses on defining indirect losses (those typically caused by corruption scandals) and MAC-related clauses. After all, a corruption scandal, for example, in a recently acquired asset has the potential to push its value close to zero.


What significant trends exist in the M&A market presently? Are you seeing these just domestically or internationally as well?

There are trends affecting the Brazilian M&A market which are observable internationally. From an economic perspective, the international pool of liquidity continues to be large given the good performance of the US, China and, to a certain extent, European markets. Although China has clearly defined the New Silk Road as its main area of investment, it is also true that many Chinese SOEs define Latin America, and especially Brazil, as one of their core areas for investment. We are also aware that many PE funds are right now operating the upstream market to potentially form pools to invest in Brazil. This is all beneficial to the domestic M&A market, in the sense it increases the cash available for investment in M&A deals.

On the other hand, we have challenges that are very specific to Brazil and Latin America. The first is the fact that we need to definitively pull out of the recession years and come up with sound economic policies to gain trust again. Our government must be reduced in size and concentrate in core areas of public service, such as education, security, health and basic infrastructure (in partnership with the private sector). Government expenses must be controlled. This, alone, could have a transformational effect in the M&A markets and business of corporate law firms in general. The size, value and relevance of assets which would be put into the market could have an effect which is similar to the privatisation of the telecommunications sector in Brazil in the ’90s. In a nutshell, making certain leading firms viable and significantly increasing the business of others.

Strictly from a legal perspective it is also a challenge to show the capital rich markets that the legal and regulatory environment in Brazil are stable. My perspective on this one is that Brazil has been successful, but there was a clear trend in cross-border deals to try and submit significant chunks of the legal work (mostly investment agreements and sharepurchase agreements) to foreign law, due to uncertainty surrounding local courts. While many tests and challenges to the stability of the legal environment were made – from the impeachment of the former president to the questioning of certain concession contracts by local populist markets – in general, the courts upheld the contracts. The visibility of the turmoil, though, clearly created a trend towards foreign law when possible.

I would also say that the influence of Anglo-American type contracts is a consolidated trend in Brazil. Our partners and associates all must have LLMs in leading US or UK universities and/or have worked in US or UK firms. Finally, we are now going through a Far East jurisdictions trend, sending associates to China and Japan and regularly visiting these jurisdictions.


What are the three biggest challenges to practising M&A in Brazil at the moment?

The first and biggest challenge has to be understanding and navigating the Brazilian tax system. The country is one of the most isolated jurisdictions in the globe and, at the same time, one of the largest. It has one of the most complicated tax systems ever devised, with taxes at the federal, state and municipal levels frequently overlapping. According to world bank data, the country is one of the most complicated tax jurisdictions. Newcomers need a premium tax counsel at the M&A stage and, after that as they regularly do business in the country.

The second challenge is bureaucracy. Although there is no foreign exchange control (in the sense of an authorisation needed for the remittance of profits, for example), foreign capital investments must be registered with the Central Bank of Brazil. The type of registry, for example, may affect the way headquarters are taxed upon sale of the investment. We have seen clients missing that little detail in the past and years thereafter going into lengthy litigation which drains their profit margin merely because red tape was not observed. One must consider and manage that from the outset.

The third challenge is, unfortunately, compliance and corruption. The recent corruption scandals clearly show that buyers must frequently submit their target companies to forensic and background checks before acquiring businesses in Brazil. After that, a thorough review of the compliance policies and the formation of a reliable compliance department is central to a successful business.


How does M&A fit into your firm as a whole? Is it easy to collaborate with other teams?

M&A is one of the main practices, together with litigation and tax, which you will probably find is also truth for any of traditional, large Brazilian law firms.

We strive to take every decision – even those that are purely internal – considering the needs of our most important stakeholders, which are the clients. For example, while revenue generation is an important element in the progression of the career of our partners, it is not the sole or automatic driver of our remuneration. Of course, those generating more business will, probably in the short term, benefit from such capacity (as in essence the clients tell who the best lawyers are by consistently hiring them), but we realise that silos may be created (and hard to break thereafter) if a firm makes a direct and immediate link between revenue generation and remuneration. Our remuneration system is thus built so that our lawyers send the work received from clients to those best suited to deliver it. No one will try and do work from another area just to get the invoice credits.

Our teams are built and respond in matrix with specific projects. In other words, we will consider all the project’s and client’s factors to staff a transaction without referring to internal silos (i.e. mentoring and management groups at the firm are not at all relevant to that purpose although, of course, at a more junior level, the associates tend to work more frequently with the same mentors). We usually staff by industry (some industries, such as life sciences and infrastructure, may get very specific), but for Chinese and some Europeans we will staff deals on the basis of language capabilities as well.

All-in-all, your question goes to the core of what we believe to be one of the most important elements of a successful M&A law firm, which is collaboration. Our system was designed to achieve collaboration and hence it is fairly easy to understand. Whatever best suits the client is implemented.


What advice would you give to the next generation of M&A lawyers?

First, our advice would be to acquire a very solid set of technical skills, preferably with the validation of a master’s degree and/or internship in a major global law firm. A solid academic background is what we define internally as a ‘must have’ set of skills. The M&A industry has very little space for technically weak lawyers. My personal perspective is that the M&A industry will only get more and more demanding with regard to technical skills. A solid academic background is very important and brings your CV through the first round of cuts. After you are in, your set of technical skills must put you pari passu with peers or above them.

Second, one needs to understand that the core business of a law firm is the client.

The work of an M&A lawyer is not only about delivering perfect works from an academic perspective. It is also about about delivering them in a timely fashion and within internationally recognised excellent service providing standards. The work product has to be technically perfect, but also correctly package for the client. In other words, on top of the technical skills you must clearly be equipped to provide services at the same levels perceived by clients in any major financial services hub worldwide.

The most important thing though, is to understand that M&A is, at the end of the day, about people. It is virtually impossible for a lawyer to deliver a project alone, as it requires thousands of hours to call a deal done. There will always be another side at the table. People will get tired and do poor work. People will make mistakes. People will crack under pressure. M&A lawyers, by the very nature of their work, are forced to lead from the front and will have to deal with these situations. It is very important to acknowledge the fact that you have to have interpersonal skills. This is possibly the most challenging element of being a successful M&A lawyer but, at the same time, as one gets more senior, the most important.


What are your predictions for M&A in Brazil over the next five years?

I tend to think the M&A industry will go through a relatively strong growth cycle, assuming the right economic measures will be taken by the next federal government, which will be elected in the impending 2018 presidential elections. This is because there is very little room for fiscal stability to be achieved other than reducing the presence of the government in the economy. That means a cycle of concessions and privatisations which, alone, have the potential to increase the level of M&A business. The level of private-to-private M&A also could very much increase as a result of more orthodox economic policies and a continued upholding of the rule of law, which, again, despite all appearances, has occurred in the country. But, again, that all depends on who wins the elections at the end of the year.