# Presentation: 106503

## By:  Jorge  Santistevan

**Legal Aspects of Doing Business in Mexico**
- Presentation for:
**Mexico Market Briefing Webex**
**Free WebEx Seminar Series for New-to-Market Firms**
***July 20, 2006 ***
- In coordination with the
**U.S. Commercial Service,  ****U.S. Embassy in Mexico**
- By:  **Jorge  Santistevan**
**Santistevan Abogados, SC**
**Legal Support for Business**** **

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## Doing Business Abroad – MexicoPrevious Homework:

- Market Research,
- Business Plan, and
- Identify People (employees and partners)
- Note: Please, do not hire or venture
- 	  with the first person that speaks English!!!

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## I.  Doing Business "WITH" Mexico"

**Sales Agent**.   With POA to bind his/her Principal in the U.S. (usually an employee).
**Commission Agent**.  Limited POA.  Take orders and receive monies.
**Distributor**.  Purchases and re-sells goods.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## 1. Sales Agent, will bind Principal. Effects:  

- (i)    Doing Business in Mexico – violation of various statutes:
- 	*  Foreign Investments Law,
- 	*  Corporate Law, and
- 	*  Registry of Commerce Law.
- (ii)   Violation of immigration laws;
- (iii)  Tax effects - permanent establishment for tax purposes - 29% tax, and taxed again on any remittances (deemed dividends);
- (iv) Agent is an employee for Mexican labor law (comments later).

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## 2.  Commission Agents

- Independent promoters
- No binding POA, limited to: take orders, and $
- No specific statute for local agents.  Arms length negotiation.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## 3.  Distributors 

- No Dealers’ Acts.  Some L.A. Jurisdictions have them (i.e. Costa Rica).  Also some States within the U.S.
- Arms length negotiation. No specific statute for local distributors.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## Secure your transaction when selling:

- Stand by L/C,
- Promissory Notes,
- Tile Reserve Agreements (large equipment),
- Acknowledgement of Debt Agreement

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## II.- Doing Business "IN BETWEEN" Mexico" 

- Agreements on: Licensing Patents or Trademarks; Technical Assistance, Provision of Know-How; Management Services; Franchising; etc.
- Arms length, basic rules of contracts - Elimination of former limiting legislation.
- Withholding of taxes on royalty payments.  Usually 25% - With U.S./Mexico Tax Treaty 10%, and in Technical Assistance 0% unless services provided within Mexican territory for more than 183 days.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  Doing Business "IN" Mexico" 

- Previous Market Research, usually by observing results from a Sales Agent or a Commission Agent or a Distributor – Market is “ripe”
- Have a Business Plan (2 to 5 years), and a commitment with Mexico
- Do not expect the quick gain
- Be “patient”– sense of timing (government, people)

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  Doing Business "IN" Mexico“  Cont...

- Personal relationships are important - Many Mexicos.
- Look for similar business value structure.
- Deals should happen relatively fast after basis for the business is established. -  If a Mexican goes in circles with no straight answer, or a “no” there is no deal.  -  Mexicans have difficulties in saying NO.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  Doing Business "IN" Mexico“  Cont...

- Previous identification of an Associate or Partner, usually from information from previous sales agents, commission agents or distributors, or  independent market research.
- In case of independent market research, is best to use the Services of the U.S. Commercial Services at the U.S. Embassy or the American Chamber of Commerce in Mexico.
- Identify his business culture & background of a prospective Executive/Manager or a Partner

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  Doing Business "IN" Mexico“  Cont...

- (i) Hard Line Approach: “...this is the way we do it in my Country and this is the way we are going to do it in Mexico..." ;  or
- (ii) Naïve Approach: “...they told me a shake hands was enough in Mexico...".

- Two psychological extreme ways of investing:

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## Doing Business "IN" Mexico“  Cont...Establishing a "Hands on Operation":

- 1)   Create your own new company, and set your operation altogether (steps to be discussed later); or
- 2)    Joint venture in Mexico (many combinations):
- 		a.  Buy Stock in an already established Company, or
- 		b.  Form a New Co. & Acquire the on-going business:
- 			i.    Acquire the Assets; and/or
- 			II.   Acquire the Personnel.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## Doing Business "IN" Mexico“  Cont... First important step

-     Getting into a Joint Venture Agreement.
- 	**Previous Step: ****	****Letter of Intent**
- 	Letter of Understanding / Interim Agreement.-   Is a previous binding agreement to discuss a possible joint venture, show mutual information, trade secrets, have a mutual confidentiality agreement.  Intellectual property and criminal laws protect confidentiality.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	JV Agreement   Cont... 

- Joint Venture.-  An agreement describing the joint undertaking (venture) by two or more parties, and for a period of time.
- It can take any form but should be always in writing.
- Verbal/oral agreements are valid in Mexico, but is recommendable to have the JV terms spelled-out in writing, otherwise the parties will face a cumbersome and burdensome evidence procedure.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	JV Agreement   Cont...

- Defines the “business equation” among the parties.  Parties will agree on how they will provide their respective contributions, share their risks and divide profits.
- Each type of business venture determines the liability and tax treatment.
- Could yield into an additional commercial company whose By-Laws will become public when registered at the Registry of Commerce.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## The JV defines the “business terms” among the parties, and only will have  effects among the parties.

This JV Agreement is not registered nor becomes public.  

The By-Laws of a Company (resulting from the JV) will only refer to the formal aspects: (i) Capital Structure, (ii) Administration of the Company, and (iii) its Agents. 

If the parties just incorporate a company with its By-Laws,  without having a previous JV Agreement, this could lead to misunderstandings. 

- This JV Agreement is not registered nor becomes public.
- The By-Laws of a Company (resulting from the JV) will only refer to the formal aspects: (i) Capital Structure, (ii) Administration of the Company, and (iii) its Agents.
- If the parties just incorporate a company with its By-Laws,  without having a previous JV Agreement, this could lead to misunderstandings.

**III.  ****	****Doing Business "IN" Mexico“  Cont...**** ****	****JV Agreement**   Cont...

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## 
Both the JV and related By-Laws of a company, have the same legal validity among the parties.

However, since the By-Laws are registered they have effects before third parties; and should normally show: 

Capital Structure (Equity Distribution). 
Administration (Governance), and
Its Agents and Representatives (Who have  Powers). 

- Both the JV and related By-Laws of a company, have the same legal validity among the parties.
- However, since the By-Laws are registered they have effects before third parties; and should normally show:
- Capital Structure (Equity Distribution).
- Administration (Governance), and
- Its Agents and Representatives (Who have  Powers).

**III.  ****	****Doing Business "IN" Mexico“  Cont...**** ****	****JV Agreement**   Cont...

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## Deriving from the JV Agreement, there are usually other documents that come as a result of the business equation, aside from the By-Laws, and depending upon the deal, example:

Loan / Financing;
Technical Assistance;
Sale of Assets;
Marketing Services;
Distribution Agreement;
Labor support and services;
Supply Agreement; etc 

- Loan / Financing;
- Technical Assistance;
- Sale of Assets;
- Marketing Services;
- Distribution Agreement;
- Labor support and services;
- Supply Agreement; etc

**III.  ****	****Doing Business "IN" Mexico“  Cont...**** ****	****JV Agreement**   Cont...

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	3) a)   Buy Stock in an established Company.

- Buying Stock requires "**Substantial Due Diligence**" to avoid finding “skeletons" in the closet.
- Areas of Due Diligence are:
**Tax**,
**Accounting**, and
**Legal**
- Also requires a good Stock Acquisition Contract which will include a "**full release and hold harmless**" provision in case of unexpected liabilities on the buyer.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	

**Establishment of a Mexican Company:**
- Foreign Investment Rules quite open except for Government Restricted Areas.  Those are areas  of economic and strategic importance, such as Oil Exploitation, Coining of Money, Power Supply, etc.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

- Several types of commercial companies.
- Usually recommended either are:
**Limited Liability Stock Corporation** ("Sociedad Anónima" or "SA"), or a
**Limited Liability Partnership** ("Sociedad de Responsabilidad Limitada" or "SRL") more like a closely held company in the U.S.
- Both may be of variable capital ("Capital Variable") so simple Stockholders'/Partners' Meetings may increase or decrease the capital without government registration.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

- In both the SA and SRL:
- (i)  Liability is limited to their capital contribution;
- (ii) Directors are liable for diligently administering the company;
- (iii) Must have at least 2 shareholders/partners, and
- (iv) Corporate tax rate will be 30%.  (to be reduced 1% every year, until reaching a maximum of 28% in 2007).
- No tax on dividends if the Mexican GAAP are followed.
- There is no exchange controls in Mexico - repatriation of dividends or other currency transfer for interest or royalties are possible (considering any applicable tax withholding).

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

**New **Stock Corporations for Promoting Investment (“Sociedades Anónimas Promotoras de Inversión”), under the new Securities Market Law.
- Eliminate certain corporate and economic on shareholders, allowing more flexibility for shareholders to agree on investment matters such as: (i) non-compete provisions; (ii) option rights (*e.g.*, right of first refusal, tag-along rights, call option and put option); (iii) sale and transfer of shares; (iv) exercise of preemptive rights; and (v) pooling vote provisions.
- No experience, since the law recently entered into effects.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## 
U.S. tax reason to decide incorporate an "SA" or an "SRL“:  

Under the U.S. IRS Rulings, for a limited liability entity (LLC, or LLP, or Subchapter “S” Corporation) benefited by a "flow-through" tax treatment (being taxed only at corporate level and not at  distribution), to be able to “mingle” its profits with those received by a Mexican subsidiary, such subsidiary should be an "equivalent" to such liability entity. For the IRS, the “SRL” (not the “SA”) is equivalent to such limited liability entity, and its profits can be mingled and have the same treatment.

The  Rulings have a “check in the box” period to advise the IRS that the profits are coming from an SRL once is established

- U.S. tax reason to decide incorporate an "SA" or an "SRL“:
- Under the U.S. IRS Rulings, for a limited liability entity (LLC, or LLP, or Subchapter “S” Corporation) benefited by a "flow-through" tax treatment (being taxed only at corporate level and not at  distribution), to be able to “mingle” its profits with those received by a Mexican subsidiary, such subsidiary should be an "equivalent" to such liability entity. For the IRS, the “SRL” (not the “SA”) is equivalent to such limited liability entity, and its profits can be mingled and have the same treatment.
- The  Rulings have a “check in the box” period to advise the IRS that the profits are coming from an SRL once is established

**III.  ****	****Doing Business "IN" Mexico“  Cont...**** ****	****Establishment of a Mexican Company:  **Cont...

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## To incorporate in Mexico it will be necessary:

Name Permit from the Ministry of Foreign Relations,  and 
Incorporate before a Notary Public 

Registrations:

Tax Registration
Registry of Commerce
Foreign Investments Registration

- Name Permit from the Ministry of Foreign Relations,  and
- Incorporate before a Notary Public
- Registrations:
- Tax Registration
- Registry of Commerce
- Foreign Investments Registration

**III.  ****	****Doing Business "IN" Mexico“  Cont...**** ****	****Establishment of a Mexican Company:  **Cont...

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

-  i)    Acquire the Assets; and/or
- ii)    Acquire the Personnel.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

**i) In acquiring Assets**
- Debts follow assets – Possible 3rd party creditors’ claims/liens.
- Draft acquisition agreement.  Real estate requires Notarization.
- Due diligence on Debts of the Seller –  Registry of Commerce
- Registry of Commerce (Merchant File for each company) for Governance and Powers of the seller company
- POA of Seller - Rules of Agency in Mexico are very formal and require written powers issued before a Notary Public and registered at the Registry of Commerce to sell company assets.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

**ii) In acquiring Personnel **
- Change of employer will rise a labor claim (change of labor circumstances).
- Employment Substitution – Possible if recognition of previously acquired labor rights, including seniority.
- Negotiation with:  Labor Union & Each employee.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

**ii) In acquiring Personnel**** **
**Employment Substitution**  -  Labor Assignment Agreement per employee – 3 parties:
-    	1. Original Employer,
-    	2. Employee, and
-    	3. New Employer (you).
- New labor contract with each employee – **Note**: Labor Law deems the existence of a “**labor relationship**” when;
- (i) “**subordination**” (follows orders),  and (ii) “**economic dependency**” (more than 50% of its daily income) exist, between a company and an individual.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

**ii) In acquiring Personnel -  ****Labor Law Situation**:
- Is protective of Employees;
- No obligation to work;
- Employees are always right until Employer proves otherwise;
- 10 % profit sharing distribution pre-tax earnings (not to the manager);
- No employment at will (the employer can not terminate at will);
- Only terminated for statutorily defined reasons;
- Mandatory severance payments are steep;
- Labor unions will “claim” title to Union Agreement (20 Emp.).   Seek for a “White” Labor Union first

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

**ii) In acquiring Personnel -  ****Labor Law Situation**:
- Like in rest of the World, the Mexican Labor law is "strongly" drafted in favor of the employees, putting the employers in disadvantage.
- Note that all terminations by an employer will be deemed dismissals without fair cause, unless proven by the employer otherwise.
- In Mexico the employee is always right until otherwise demonstrated before the Labor Board.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## III.  	Doing Business "IN" Mexico“  Cont... 	Establishment of a Mexican Company:  Cont...

**ii) In acquiring Personnel -  ****Labor Law Situation**:
- In the event of dismissal, the employees can basically claim:
- Three (3) months of salary;
- Twenty (20) days of salary for each year of employment;
- Seniority premium equal to twelve (12) days salary per year of employment;
- Salaries accrued from the date of termination to the date of payment of indemnities (“salarios caidos”); and
- Their accrued fringe benefits during the calendar year. The statutory fringe benefits are:
- Vacation: at least 6 working days per year, payable at 125% of salary per day;
- Annual Bonus: at least 15 days of salary; and
- Profit Sharing: 10% of pre-tax earnings of the company - distributed among all employees depending upon the number of days worked and salaries in the year.

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## 
ii) In acquiring Personnel -  Labor Law Situation:

Reduction of Labor Risk – Two companies.

It has been customary in the last years to form an additional "Services" company which holds the employees reducing reduce labor risks, on the "Operating" company.

The Operating Company will do the business and yield profits.

**ii) In acquiring Personnel -  ****Labor Law Situation**:
**Reduction of Labor Risk – Two companies**.
- It has been customary in the last years to form an additional "Services" company which holds the employees reducing reduce labor risks, on the "Operating" company.
- The Operating Company will do the business and yield profits.

**III.  ****	****Doing Business "IN" Mexico“  Cont...**** ****	****Establishment of a Mexican Company:  **Cont...

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## ii) In acquiring Personnel -  Labor Law Situation:

Operating Company  &  Services Company

Both companies will be related by a Inter-Company Services Agreement.

In the inter-company agreement, the Operating Company will pay to the Services Company a fee for all the employees services.  This fee will be equal to the labor cost (pay-roll cost) and a minimal plus (i.e.1%).   

The Services Company will become cost center and there will be no profits to share with the employees. 

**Operating Company  &  Services Company**
- Both companies will be related by a Inter-Company Services Agreement.
- In the inter-company agreement, the Operating Company will pay to the Services Company a fee for all the employees services.  This fee will be equal to the labor cost (pay-roll cost) and a minimal plus (i.e.1%).
- The Services Company will become cost center and there will be no profits to share with the employees.

**III.  ****	****Doing Business "IN" Mexico“  Cont...**** ****	****Establishment of a Mexican Company:  **Cont...

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006

## Santistevan Abogados, SC

**We hope for your successful business in Mexico!**
**Respectfully,**
**Jorge  G. Santistevan**
**Santistevan Abogados, SC**
**Legal Support for Business**

- © Santistevan Abogados, SC   http://www.santistevan.com.mx

- July 20, 2006