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25 November 2020
On 11 August 2020 StoneCo Ltd, a Brazilian provider of electronic payment and payment processing solutions listed on the NASDAQ Stock Market, announced the execution of an association agreement to merge its business with Linx SA, a leading provider of retail management software in Brazil listed on the Brazilian Stock Exchange (B3).
Under the association agreement, the merger of Stone and Linx would be implemented through a corporate reorganisation consisting of:
In financial terms, Stone's offer valued each Linx share at R33.76 (approximately $6.02), representing a total amount of R6.04 billion (approximately $1.07 billion)
The association agreement required Linx to execute any merger transaction exclusively with Stone and provided for a break-up fee of R605 million (approximately $100 million) to be paid by Linx to Stone. The total break-up fee comprised:
On the other hand, Stone was required to pay Linx the break-up fee if the transaction was rejected by the Brazilian antitrust authority.
Aside from the significant break-up fee, another controversial aspect of Stone's offer was the provision of an additional payment of R315 million (approximately $56 million) to Linx's founding shareholders as compensation for the non-competition agreements executed with them and the executive engagement proposal executed with one of the founders. This provision was strongly criticised and viewed as a premium of 35% for the controlling interest disguised as non-competition compensation.
In the midst of this uncertainty, on 14 August 2020 TOTVS SA, a Brazilian technology company listed on B3 and specialised in the development of business solutions for companies, formalised a hostile takeover offer to buy Linx for R6.10 billion (approximately $1.08 billion) (TOTVS's offer). The transaction consisted of a corporate reorganisation that would result in Linx being 100% controlled by TOTVS. According to the terms of TOTVS's offer, Linx's shareholders would receive, for each Linx share held by them, one share of TOTVS and R6.20 (approximately $1.10). TOTVS's offer valued each Linx share at R34.09 (approximately $6.08). If such transaction was concluded, Linx's shareholders would own shares equal to approximately 24% of TOTVS's total and voting capital.
On 1 September 2020, as Stone's offer started to compete with TOTVS's offer and the provisions of Stone's offer were called into question, Stone and Linx executed an amendment to the association agreement, through which Stone increased the compensation for each of Linx's shares to R35.10 (approximately $6.26), increasing the total offer amount to R6.28 billion (approximately $1.12 billion). Moreover, Stone revised the offer to reduce the break-up fee to R453.75 million (approximately $80 million) and renegotiated with Linx's founding shareholders the non-competition agreements and the executive engagement proposal.
On 17 November 2020 Linx's board of directors called an extraordinary general meeting to submit Stone's proposal to merge Linx's shares for shareholder approval. TOTVS's offer was not included in the meeting's resolutions as Linx's independent committee, formed with the sole purpose of evaluating TOTVS's offer, claimed that it was missing important elements which would provide a better understanding of all of the benefits and risks associated with TOTVS's offer.
TOTVS's directors considered the independent committee's justification for recommending the acceptance of Stone's offer and the non-submission of TOTVS's offer to be misleading. According to TOTVS, the independent committee's position consisted of privilege conceded to Stone, as Stone's offer attributed special benefits to Linx's founding shareholders that were not provided for in TOTVS's offer.
Regardless of the above, TOTVS maintained its hostile takeover offer, announcing to the market the possibility of increasing the price for Linx's shares and extending the validity of its offer until 31 December 2020. TOTVS also questioned the impartiality of Linx's independent committee. One particular aspect addressed in the announcement was the illegality of the break-up fee agreed between Stone and Linx on the grounds that it burdened the free voting rights of Linx's shareholders. In TOTVS's view, the break-up fee could result in the liability of Linx's directors as they had validated its existence and conditions.
As the 17 November 2020 extraordinary general meeting approached, TOTVS intensified its efforts to acquire Linx. For that purpose, TOTVS's directors called a general meeting to submit the protocol of merger and justification – a document required by the Corporations Act (Law 6,404/1976) for the implementation of mergers – for shareholder approval, which would authorise the merger with Linx. TOTVS's directors had not previously agreed the referred approval with Linx's directors, which caused even more conflict between TOTVS and Linx. TOTVS's position indicated that even if the approval of its offer was conditional on the rejection of Stone's offer, it would not end its dispute with Stone.
In response, on 29 October 2020 Stone once again amended the association agreement to exclude the break-up fee due for the non-approval of Stone's offer by its shareholders (which represented 25% of the total break-up fee) and to increase the compensation by R0.50 (approximately $0.08) for each Linx share. These changes corresponded to a total increase in Stone's offer of BR89.5 million (approximately USD 16 million).
On 13 November 2020 the Brazilian Securities and Exchange Commission (CVM) granted the appeal presented by Linx's founding shareholders to allow them to vote on the resolutions regarding Stone's offer (Proceedings 19957.005563/2020-75). Initially, the CVM had prevented Linx's founding shareholders from voting at the 17 November 2020 extraordinary general meeting. However, the majority of the board of CVM understood that the case did not constitute a situation of personal benefit for Linx's founding shareholders, as per the Corporations Act, and that the compensation due to them for the non-competition agreements and the executive engagement proposal did not result in a conflict of interest which necessitated a voting restriction. Nonetheless, the CVM expressly stated its right to posteriorly verify the legality of the votes of Linx's founding shareholders given at the 17 November 2020 extraordinary general meeting.
On the same day, the CVM decided two other proceedings regarding this case, in which it rejected the shareholders' requests for the postponement of the 17 November 2020 extraordinary general meeting and the interruption of the call term for the same.
Although the CVM's decisions were favourable for the approval of Stone's offer, Stone intended to ensure that its offer was approved at the 17 November 2020 extraordinary general meeting. Thus, on the morning of 17 November 2020, shortly before the meeting, Stone increased the cash portion of the consideration to be paid to Linx shareholders by R1.50 (approximately $0.26) per share. As a result, each Linx share would receive a cash consideration of R33.56 (approximately $6), plus 0.0126774 Stone Class A shares, increasing the total consideration to R38.06 (approximately $6.79) per share. The total increase in Stone's offer corresponded to RL268,587,925.50 (approximately $47.96 million).
At the 17 November 2020 extraordinary general meeting, Linx's shareholders voted and approved Stone's offer, with 97 million shares in favour of the transaction compared with the required 87.5 million shares. This suggests that Linx's shareholders were uncertain about approving Stone's offer, as the votes of Linx's founding shareholders – who own more than 20 million of Linx's shares – were essential to approve the resolution.
In contrast to most publicly held companies in Brazil, Linx is a widely held stock company, in which the controlling shareholders (ie, its founders) own only 14.25% of the shares. As is common knowledge in developed and sophisticated markets, the existence of widely held stock companies leads to hostile takeover attempts. The Brazilian market is not used to hostile takeovers because most companies have a controller group which owns 50% or more of the voting shares. However, this looks set to change as there has been a slight change in the profile of Brazilian investors and the capital structure of companies due to a significant injection of foreign capital in the Brazilian market. This has boosted the number of widely held companies with no specific owner and will likely lead to more hostile takeover offers in future.
Hence, the dispute between Stone and TOTVS over the acquisition of Linx has brought to light many important matters, especially directors' responsibility for damages caused to a company or its shareholders. TOTVS presented a hostile offer, which faced resistance from Linx's board of directors from the start. The source of this resistance is unknown, but TOTVS insists that it is linked to the compensation that will be paid to Linx's founding shareholders under the non-competition agreements and the executive engagement proposal executed with them (which was construed by some analysts as a premium for the controlling interest). Notably, Linx's founding shareholders are members of its board of directors.
In Brazil, the Corporations Act provides for specific principles and obligations for directors and officers regarding the performance of their duties. Broadly speaking, directors and officers have:
These legal provisions ensure that directors' and officers' duties are performed in the company's best interests, regardless of the interests of the shareholders that appointed them, thus avoiding any situation that may represent a conflict of interest between a director or officer and the company. Thus, under such regulations, directors and officers must not intervene in transactions which would create a conflict of interest with the company.
As stipulated by TOTVS in a material fact, in widely held companies, directors' and officers' duty of care and fiduciary duty are even more relevant for the protection of minority shareholders. In such companies, there is no controlling group of shareholders that effectively conducts the company's business by using their votes in general meetings or appointing the majority of the directors and officers. Therefore, directors and officers assume a significant role by effectively conducting the company's business and pursuing its best interests. If the directors or officers have a conflict of interest with the company, the shareholders could be significantly aggrieved.
Brazilian legislation includes no specific principles and obligations for directors involved in a tender or hostile takeover unless the company is subject to rules provided for in the Novo Mercado regulation – a special listing segment of B3 that requires boards of directors to issue a report for the shareholders' evaluation, setting out:
As Linx and TOTVS were in the Novo Mercado segment, in addition to the general principles and obligations provided for in the Corporations Act, the specific rules mentioned above also applied. A regular tender or hostile takeover attempt would demand a meticulous analysis from a legal perspective to avoid director and officer liability arising from a breach of their fiduciary duties. Extra care was required in the Linx-TOTVS case since they were obliged to comply with the specific rules of the Novo Mercado segment.
For that reason, the CVM closely followed the transaction and, in addition to the abovementioned proceedings, has already started two administrative processes in this respect. The first process aims to analyse the conditions of the transaction, while the other consists of an investigation regarding the use of insider information in the transaction with Stone, as Linx's paper prices went up by 10% after the first announcement of a potential transaction with Stone.
That said, the CVM has not interfered in the transaction to date and, when presented with both offers, Linx's shareholders chose to approve Stone's. Despite the resulting dispute, the benefits of having a concurrent offer – albeit a hostile one – were clear to Linx's shareholders. Regardless of Linx's resistance to TOTVS's offer, as a result of the dispute, Stone repeatedly changed the terms and conditions of its association agreement to make it more favourable to all shareholders (including minority shareholders). Stone may have won the dispute, but it had to pay an extra R600 million (approximately $107 million) to do so, which is precisely the benefit of having a competitive capital market.
For further information on this topic please contact Bernardo Freitas, Isabela Ardaya or João Cesconi at Freitas Ferraz Advogados by telephone (+1 410 244 7400) or email (firstname.lastname@example.org, email@example.com or firstname.lastname@example.org). The Freitas Ferraz Advogados website can be accessed at www.freitasferraz.com.
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