Focus: Legal

The Set Up

The Set Up

Jul. 17, 2013

RESTRICTIONS ON FOREIGN INVESTMENT

Foreign investment in Mexico is ruled mainly by the Foreign Investment Law effective as of December 28, 1993, which opened the possibility for foreigners to invest in several economic activities that had been formerly restricted. The law reserves 10 areas exclusively to the Mexican state and five others to Mexican nationals or corporations that have a foreign investment exclusion clause incorporated in their bylaws.

The general rule provides for foreign investors to participate in Mexican companies owning up to 100% of the equity, without needing the prior approval of the Mexican government, but having the obligation to register the investment with the National Registry of Foreign Investment. There are some restrictions to the above-mentioned rule—for example, in the case of activities pertaining to the printing of newspapers and management of retirement funds, among others—where foreign investors may only hold 49% of the company's equity. In some other activities such as legal consultation, in order for foreign investment to participate in more than 49% of the company's equity, it is necessary to obtain the previous authorization of the National Foreign Investments Commission. Such authorization shall also be necessary, pursuant to Article 9 of the Foreign Investment Law, whenever a foreign investor intends to acquire, directly or indirectly, more than 49% of the equity of a Mexican company if the value of the total assets of the company, at the time of filing the request for the acquisition, exceeds the amount annually determined by the commission itself.

Under the Constitution of Mexico, foreign individuals or entities have certain restrictions to hold legal titles to real estate in Mexico located within 100 kilometers of the border lines and 50 kilometers from the coastlines. Nevertheless, foreigners may hold the beneficial interest to such real estate indirectly, through a trust, provided that trusts created for such purpose shall have a Mexican bank acting as trustee. Mexican companies with foreign investment may directly hold legal titles to real estate located within the above-mentioned boundaries if they engage in non-residential activities and provided that bylaws contemplate the foreign admission clause granted by the Ministry of Foreign Affairs. Recently, there have been discussions that would result in amendments to the law to enable foreigners to freely own real estate in the so called “forbidden strip," but no laws have been passed to that effect so far. Additionally, the Foreign Investment Law provides the ability to participate in restricted activities through so-called “neutral investments," which enable Mexican companies to obtain external funds and financing through the sale of shares with no voting rights and limited corporate rights held by authorized trusts to foreign investors.

TYPES OF BUSINESS ENTITIES

Generally, investments by foreigners in Mexico are made through two types of corporate vehicles regulated by the Mexican Mercantile Companies Law: (i) limited liability companies (sociedades de responsabilidad limitada or SRL); or (ii) corporations (sociedades anónimas or SA). Although there are other corporate organization forms, SAs and SRLs are the prevalent forms of corporate organization. Additionally, investments can also be made through other structures such as trust agreements, which can vary on purposes based on the particular needs of a specific investment. SRLs are commonly used by US investors because they qualify as pass-through entities for US tax purposes, since they resemble a closed corporation or partnership.

On the other hand, SAs are more commonly used by Mexican and non-US investors, since they operate as general corporations, which permits a more flexible transfer of equity. All publicly traded companies must be SAs, identified as public corporations (sociedades anónimas bursátiles or SABs).

Since the enactment of Mexico's current Securities Market Laws, a new type of SA was introduced, the sociedad anónima promotora de inversión (SAPI); this type operates as a regular SA, but may introduce in its bylaws more complex voting and distribution structures, preemptive rights, call and put options, and other types of provisions customary in certain joint-ventures. The principle behind the creation of a SAPI is to enable the participation of certain types of investors in a company that will aid in the company's institutionalization and development. Once its investment cycle is completed, or the company has acquired critical mass, the intention (but not the obligation) is that the SAPI must carry out an IPO and convert into an SAB. Currently, much of the foreign investment in Mexico, particularly by certain types of investors such as funds, is being carried out through a SAPI, where the investor can ensure certain economic or voting rights that help achieve a level of comfort that investors are seeking for their investments.

RECENT REFORMS TO LABOR REGULATIONS

For several years, pundits have talked about the so-called “structural reforms" that Mexico needs in order to significantly increase its annual GDP growth. One of them was a full revamping of the Federal Labor Law (Ley Federal del Trabajo), which finally took place in November 2012. This is a landmark change, as there had been many unsuccessful attempts to undertake these amendments. Amid strong media coverage and political controversy, on November 30, 2012, the then Mexican president, Felipe Calderón, enacted a set of amendments to the Federal Labor Law. Among the most relevant changes found in the bill are (i) the incorporation of the labor principles recognized by the International Labor Organization, namely a policy of non-discrimination in the labor environment, (ii) three brand-new employment modalities (i.e., the “initial training contract," the “contract on trial," and the “seasonal discontinuous contract"), and (iii) the new subcontracting regime.

Prior to the reforms, the typical workforce sourcing structure entailed a holding company (HoldCo), which owned two separate entities, an operative company (OpCo), and a service company (ServiceCo), which provides the entirety of the workforce to the OpCo under a service agreement. This allowed a company to manage its profit-sharing payments, one that is required by law to equal 10% of the company's distributable profits. To the extent the ServiceCo had complied with its corresponding employer obligations, or fully covered any payments due under labor related judgments, the OpCo and its profits were usually isolated from any potential labor liability incurred by the ServiceCo. This widespread traditional structure had been effective in isolating the OpCo from employee complaints and was particularly useful for employee profit-sharing planning.

Under the provisions of the newly amended Federal Labor Law, a three-pronged test shall be used to determine if a subcontracting regime is valid: (i) the number of workers providing the services; (ii) the type of work being carried out by the subcontracted employees; and (iii) the types of services provided, which must be different than those provided by the rest of the contracting party's workers.

Under the old structure, this test would not be satisfied given that the ServiceCo usually provides the entire workforce. Thus, under the new Federal Labor Law, the OpCo would be considered the employer, and would be directly responsible for all labor-related costs, including employee profit sharing and social security obligations. Note however that, even under the old structure, there had always been the risk that in some instances that the workforce provided by the ServiceCo would claim that its true employer was the OpCo, alleging that it is the latter that received the subordinated work. Therefore, the new regime does not add a new risk in this respect, and it simply clarifies the characteristics that this subcontracting regime must adhere to and the consequences for not doing so. Additionally, the new Federal Labor Law also provides for certain other obligations that must be observed when setting up a subcontracting regime. One of these obligations is that the subcontracting company must confirm that the subcontractor has the capability of providing the required services and the documentation that supports its compliance with labor and social security provisions.

Additionally, it is important that investors entering into these types of regimes keep in mind that Federal Labor Law makes it clear that the new subcontracting regime is not permitted when the contracting party deliberately transfers employees to the contractor with the intention of diminishing labor benefits and rights or avoiding liability. Should a contractor be found to be unduly using a subcontracting structure for these purposes by a labor board it could be subject to fines ranging from $1,200 to $28,000.

Although it remains to be seen how the labor boards and courts will understand the new subcontracting legal regime and apply the existent judicial precedents to these new structures, they will be targeted by the upcoming claims alleging the breach of these new statutes. Existing companies should review their current structure in order to assess compliance with the discussed new obligations and, in its case, begin remedial actions to avoid any possible claim. Likewise, new investors should consider the implications of the Federal Labor Law when considering the structures under which they will operate in Mexico.

ADVERTISEMENT