Trouble in paradise

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MULTINATIONALS seem as convinced as ever that “Brazil is the country of the future”—as it always has been. Foreign direct investment was a record $31 billion last year (among emerging economies, only China got more) and the government expects a similar amount this year. Much of the money is going on snapping up existing companies. But several recent cases show that buyers must watch out for nasty surprises.

Consider Spains Banco Santander. In January it agreed to buy Bozano, Simonsen, an investment bank. Then it emerged that the Brazilian bank had been routing money through offshore “fiscal paradises” to avoid taxes. If the tax authorities judge the scheme inadmissible, Bozano, Simonsen will have to pay perhaps 1 billion reais ($550m) in back taxes and fines, equivalent to more than half its market value. Fortunately for Santander, this bad news emerged in time for it to insist that the banks seller, Julio Bozano, deposit enough money in an escrow account to cover the possible tax bill.

MCI WorldCom, an American telecoms firm, may not be so lucky. After it bought Embratel, a long-distance operator, from the government, it was slapped with a 1.3 billion reais tax bill over profits made on international calls while Embratel was still owned by the state. The government insists that MCI knew it might face this bill when it bought the firm; MCI insists otherwise.

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The peculiarities of Brazils tax and legal systems make such unexpected bills a bigger worry than in most other countries, says Steve Rimmer of KPMG. a consultancy. Elsewhere, past liabilities can be left behind by buying a companys assets and goodwill, rather than the firm itself. Quirky Brazilian laws often rule out such dodges. And Brazils judges enjoy broad autonomy in interpreting laws, which, like tax rules, have suffered frequent changes during the countrys past 20 years of economic turmoil.

Tax demands can also arise from local firms tendency towards downright illegal behaviour. Many companies divert part of their takings into a second set of accounts, known as a caixa dois. which the taxman never sees. Law-abiding foreign buyers can put a stop to such fiddles, but they still risk paying for the previous owners misdeeds.

Another common danger is that a buyer will be sued by the acquired firms former workers. Brazils labour laws are biased towards employees, and big firms have to hire lawyers to fight suits that would be laughed out of court elsewhere. Ex-employees often put in claims for up to five years of unpaid overtime. The burden of proof lies with the employer. A business may not officially have a pension scheme (and thus pension liabilities), but if some retiring workers have received a payout in the past, the courts may rule that all workers must get one. It has become standard practice for a would-be acquirer to pore over the targets employee records and labour practices before committing to a deal.

Business fraud is a serious problem in Brazil, as elsewhere in Latin America, and the climate of insecurity inside firms being sold can make scams more likely, says Marcelo Gomes of GBE. a firm of financial detectives in Sao Paulo. The “due diligence” checks that buyers make on their potential purchases usually last only a few days, which is often too short a time to detect even simple fiddles such as the forging of invoices, he says.

Frauds may begin only after a firm has changed hands. For example, in one of Mr Gomess recent cases, the managers kept on by the new owner began diverting the firms purchases through “brokerages” set up by those made redundant, the aim being to overcharge the firm and split the proceeds. Buyers of firms seldom have time to make background checks on key employees, to find out whether they have other, conflicting business interests, or whether they enjoy a lifestyle out of all proportion to their salary.

The sheer volume of investment pouring into Brazil means that a foreign buyer has an uncomfortable likelihood of stumbling upon dodgy dealings. But a simple solution is for buyers to demand, as in the case of Bozano, Simonsen, that part of the proceeds be set aside to cover any nasty surprises from whatever direction. Buyers can also insist on the right to renegotiate the price or even pull out if skeletons emerge in the first few months after they take over. Call it a new way of ensuring Brazils bright future.