SAPIs to promote private equity in Mexico

Author: | Published: 1 Apr 2006
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Private equity investments have boomed in the past several decades, particularly in the US and other developed nations, where most private equity investments are concentrated. Latin America lags far behind. It receives around 1% of global private equity flows, of which Mexico only receives 10% - by no means representative of the size and importance of the tenth largest economy in the world and the leading economy in Latin America (according to the World Bank). Although private equity transactions have increased at a steady pace in Mexico over the last 10 years, they have done so under an outdated and inadequate legal framework.

Institutional investors seeking an equity participation in a new high-risk venture require a legal framework that affords them certainty and security. The main elements of a private equity transaction, such as shareholder agreements, voting covenants, transfer restrictions and exit rights, are either not regulated or are prohibited under Mexican law. This translates into complicated deal structures, higher transaction costs and a higher risk profile leading to a higher cost of funds for Mexican target companies and sponsors.

In December 2005, after four years of on and off efforts to create a statutory platform designed to govern private equity investments, including contemplation of a specific private equity law, the Federal congress of Mexico approved the amended and restated Securities Market Law (Ley del Mercado de Valores; the LMV), which contains a specific chapter applicable to private equity transactions.

Specifically, the LMV contemplates a new type of corporation, the sociedad anónima promotora de inversion, or SAPI, which is designed to accommodate private equity investments, and serve as a transition from a closely held corporation into a publicly traded company.

Rationale behind the SAPI

The LMV acknowledged the fact that existing Mexican corporate and commercial laws were ill equipped to accommodate private equity investments. The response was the introduction of the SAPI, a new form of limited liability corporation designed to serve as target company for, and recipient of, private equity capital.

The chapter of the LMV dealing with the SAPI is structured on the fundamental legal principal that parties to any agreement should be free to bargain what they believe is necessary to carry out the commercial transaction in question. Although this concept seems inherent to commercial law and commercial contracts, unfortunately Mexican law often limits this freedom on grounds of public policy or public order. This paternalistic view, which is common in other civil law jurisdictions, is responsible for many provisions that have historically been obstacles to structuring and executing private equity transactions.

Acknowledging the importance of allowing parties to freely negotiate agreements, the LMV establishes a legal regime that is meant to exempt SAPIs from the application of certain restrictive provisions of the 1932 General Commercial Corporations Law (Ley General de Sociedades Mercantiles; the Corporations Law), including Articles 112, 113, 132, 134 and 198.

As further described below, the LMV provides, among others, that the shareholders of SAPIs may execute shareholders agreements, and may freely negotiate investment and governance arrangements otherwise prohibited or limited under the Corporations Law.

The SAPI

The SAPI is a limited liability stock corporation. Mexican stock corporations may be incorporated as a SAPI, or may adopt the form pursuant to a transformation resolution adopted by its general extraordinary shareholders meeting.

Although SAPIs are established in the LMV, they are not subject to the regulation or supervision of the Mexican Banking and Securities Commission (Comisión Nacional Bancaria y de Valores). SAPIs are closely held corporations so their shares need not be registered before the National Securities Registry (Registro Nacional de Valores) or listed on any stock exchange.

Regulation by exemption

As a means of accommodating most forms of private equity investments, and the features and provisions that are commonplace for such transactions in most developed economies, the LMV allows the shareholders of a SAPI to negotiate arrangements dealing with the following principal areas without regard to the restrictions established in the Corporations Law:

  • Classes of shares. SAPIs may issue common shares, shares with limited or no voting rights, and preferred shares. The LMV allows for the issuance of limited voting shares without the need to grant the shareholders a right to receive preferred distributions, which is a general equitable principle established in the Corporations Law. The LMV allows for the issuance of golden shares, casting shares or similar securities, granting preferential voting or other rights to their holders.
  • Voting restrictions. Shareholders may establish voting restrictions otherwise prohibited under Article 198 of the Corporation Law. Hence, the LMV would allow shareholders to covenant to vote or abstain from voting on certain matters or in certain circumstances. Likewise, shareholders of SAPIs may assign their voting rights.
  • Preemptive rights. Shareholders of a SAPI may waive or assign their preemptive rights to subscribe and pay capital increases, even before the shareholders' resolution is adopted approving the relevant capital increase. The relevant provisions also allow for the implementation of punitive dilution and other remedies for shareholders defaulting on their capital commitments or capital calls.
  • Transfer restrictions. The LMV specifically contemplates the right of shareholders to establish lock-up periods, rights of first refusal, rights of first offer, as well as tag-along and drag-along rights.
  • Liquidity/exit. SAPIs are not restricted from repurchasing their own shares, which in terms of liquidity or exit allows the shareholders to put their shares to the actual SAPI. In addition, shareholders of a SAPI may establish specific registration rights designed to take the SAPI public, as well as put-and-call mechanisms among the shareholders.
  • Non-compete. Subject to applicable competition law, and other enforceability questions under Mexican law, shareholders of SAPIs may establish non-compete or exclusivity covenants.
  • Dispute resolution. The shareholders of a SAPI may establish dispute resolution mechanisms, including mechanisms triggered by fundamental business disagreements that trigger buy-sell schemes.

The LMV expressly recognizes the validity and effectiveness of shareholders agreements among the shareholders of a SAPI. This allows the shareholders to establish their arrangements without the need to replicate the relevant agreements and undertakings in the SAPIs by-laws, which are available to the public through the commercial registry of the company's corporate domicile.

Minority rights and corporate governance

The LMV establishes minority rights and protections for SAPIs that are similar to those that apply to publicly traded companies. Among other rights, the LMV lowered thresholds for the appointment of directors and statutory auditors from 25%, under the Corporations Law, to 10%.

One of the drivers behind the creation of the SAPI was to establish a new form of corporation that could be used by closely held corporations to transition more smoothly to publicly traded status. Hence, SAPI's are given the option to adopt (even gradually) the corporate governance provisions applicable to publicly traded companies. SAPI's that elect to adopt the corporate governance standards of listed companies will be subject to the more stringent governance schemes. Among others, the LMV specifies the authority and duties of the board of directors and the chief executive officer of a listed company, and contemplates certain standards that are novel to Mexico, such as the standard of loyalty, the standard of diligence and business judgment rule.

Towards a modern framework

Although some would question the convenience of regulating private equity and the SAPI through the LMV, which is the statute governing the Mexican securities market and publicly listed companies, there is no question that the SAPI is a step towards creating a modern and dynamic legal framework suitable for private equity. The idea of regulating by exemption and eliminating the application of the provisions in the Corporations Law that have long been identified as obstacles to the adequate structuring of private equity investments, was creative and practical, as it will make the SAPI a laboratory of sorts to determine the necessity and convenience of maintaining certain restrictions and alleged protections contemplated in the Corporations Law.

Should the SAPI prove to be a popular and useful vehicle for private equity, this will reignite calls for a complete overhaul of the Corporations Law, which many have argued is really what is required to update Mexican statutes to the requirements of the 21st century. In any event, Mexican government officials and legislators should not lose sight that a new legal framework that essentially brings Mexico up to par with other countries in terms of corporate law will not alone attract private equity investment. For such purposes, government officials need to enact much needed legislation to open new markets such as energy and transportation, and implement tax legislation that promotes private equity investment.

The partners of Creel García-Cuéllar y Müggenburg would like to thank associates Dina Moreno and Jorge Montaño for their valuable contributions to this article.