Issue6 Legal and Compliance Issues for Chinese Enterprises Investing in Mexico
Mexico stands as a beacon of opportunity for businesses seeking to expand into North and Latin America, boasting a stable economy and a strategic geographic location. Mexico's extensive network of trade agreements, coupled with its commitment to open markets and foreign investment, positions it as one of the most trade-friendly and open economies in the world. This hot topic introduces how to set up foreign companies in Mexico, also management structures, tax system, labor law of Mexico as well as dispute resolution in Mexico.
1. Overview
Mexico stands as a beacon of opportunity for businesses seeking to expand into North and Latin America, boasting a stable economy and a strategic geographic location. Mexico's extensive network of trade agreements, coupled with its commitment to open markets and foreign investment, positions it as one of the most trade-friendly and open economies in the world. In 2022, Mexico was the second largest recipient of foreign direct investment in Latin America. According to UNCTAD's World Investment Report 2023, foreign direct investment inflows increase by 11.9% to USD $35.3 billion in 2022.
In 2024, Mexico continues to attract foreign investment across various sectors, including manufacturing, technology, energy, real estate and finance. Understanding the legal framework and business environment is crucial for those considering entering the Mexican market or expanding their operations within the country.
2. Branches and Representative Offices
Pursuant to Mexico's Foreign Investment Law ("FIL"), a foreign company seeking to establish and register a branch or representative office in Mexico must request authorization from the Mexican Ministry of Economy ("ME"). The ME is required to respond to the application within 15 business days of its filing. However, certain resolutions issued by the National Commission of Foreign Investments of the ME, exempt foreign companies from China, Argentina, Australia, Austria, Bolivia, Brazil, Canada, Chile, Colombia, Costa Rica, Cuba, Denmark, Dominican Republic, Ecuador, El Salvador, France, Germany, Guatemala, Honduras, Italy, Japan, Netherlands, Nicaragua, Nigeria, Norway, Peru, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, United Arab Emirates, United Kingdom, United States and Uruguay from the requirement to obtain such authorization and will only need to submit a notice with certain details regarding the foreign company.
It is important to highlight that, any document submitted in a language other than Spanish before a Mexican governmental authority, must be translated into Spanish by a certified translator and include the corresponding apostille (if applicable).
3. Mexican Entities
The Mexican General Law of Business Organizations ("GLBO") and the Mexican Securities Markets Law consider various types of business entities, setting out the rules for their incorporation and corporate governance. However, the most common forms of business entities incorporated in Mexico are (a) corporations such as Sociedades Anónimas de Capital Variable or "S.A. de C.V.", and Sociedades Anónimas Promotoras de Inversión de Capital Variable or "S.A.P.I. de C.V.", or (b) limited liability companies named Sociedades de Responsabilidad Limitada de Capital Variable or "S. de R.L. de C.V.".
Foreign investors, particularly those from the US, often choose to establish limited liability companies due to the limited liability protection they offer to partners and their favorable treatment for US tax purposes as pass-through entities. However, corporations are also commonly incorporated by foreign investors.
Sociedades Anónimas Promotoras de Inversión de Capital Variable are specifically designed to promote investments, offering greater flexibility in share structure and rights restrictions for shareholders. Additionally, such business entities enhance the protection available to minority shareholders and offer greater flexibility for exit strategies.
4. Incorporation Process
The process to incorporate corporations and limited liability companies in Mexico is quite straightforward and involves the following:
(i) obtaining a permit from the ME to use the corporate name chosen; and
(ii) execution of a public instrument before a Mexican Notary Public (Notario Público) whereby the shareholders or partners agree the by-laws of the newly formed company. The foregoing public instrument can be executed by a legal representative of the foreign company and includes rules regarding the organization and management of the newly formed company, the appointment of the board of directors or managers, the appointment of the statutory examiner (usually a partner of an external auditing firm), among others. The Notary Public will issue several copies of such public instrument, which the shareholders or partners of the newly formed company will use to (A) obtain the Tax ID from the Ministry of Finance and Public Credit ("SHCP"); (B) register the newly formed company in the National Foreign Investment Registry of the ME; and (C) register the newly formed company in its local Public Registry of Commerce.
In order to execute the public instrument provided in section (ii) above, the legal representative of the foreign company must have a notarized power-of-attorney, translated into Spanish, with the corresponding apostille attached, and formalized before a Mexican Notary Public.
5. Opening a Bank Account
It is crucial to request the Tax ID from the SHCP immediately after the entity has been incorporated to avoid delays in commencement of operations. A Tax ID is necessary for opening bank accounts and producing invoices.
While banks in Mexico provide various account types, the most common among companies is the checking account. To open one, a company must provide the bank with several documents, including the public instrument whereby the company was incorporated, proof of address (such as a utility bill), ID and power of attorney of attorneys in fact opening the bank account and who will have authority to manage such bank accounts and the company's Tax ID, among others. Branches or representative offices of foreign companies may also need to provide a copy of the authorization from the ME, if applicable.
Banks in Mexico adhere to know-your-customer requirements and other regulations similar to those in other jurisdictions.
6. Foreign Investment
When setting up a Mexican company, it is important to consider Mexican Foreign Investment regulations.
As a general rule, the FIL allows foreign investors and Mexican companies controlled by foreign investors, without prior approval, to (a) own up to 100% of the equity of Mexican companies; (b) purchase fixed assets from Mexican individuals or entities; (c) engage in new activities or produce new products; (d) open and operate establishments; and (e) expand or relocate existing establishments. The only exceptions to this general rule are those explicitly provided in the FIL itself or, in the case of the financial sector, in the applicable regulations to Mexican financial entities.
However, the FIL specifies certain economic activities that are (i) reserved to the Mexican government; (ii) reserved to Mexican nationals or Mexican companies without foreign equity participation; (iii) subject to quantitative foreign investment limitations; and (iv) subject to prior approval if the foreign investor wishes to own more than 49% of a company engaged in certain activities.
Neither Mexican nor foreign investors may engage in certain economic activities such as: (A) exploration and extraction of petroleum and other hydrocarbons; (B) planning and control of the national electricity system as well as the public service of transmission and distribution of electricity; (C) nuclear energy generation; (D) radioactive minerals; (E) telegraphs; (F) radio telegraphy; (G) postal services; (H) currency issuance and minting coinage; (I) control, supervision, and security of ports, airports, and heliports; and (J) certain others expressly indicated under the applicable regulations.
Some of the activities reserved by the FIL for Mexican nationals and Mexican companies without foreign equity participation include: (I) domestic land transportation of passengers, tourism, and cargo, excluding messenger and courier services; (II) development banks; and (III) professional and technical services reserved for Mexicans under the corresponding legislation. However, foreign companies and individuals may participate in the above-mentioned activities through specially approved "neutral" shares without voting rights or with limited corporate rights, as approved by the National Commission of Foreign Investments.
Please note that the FIL provides other rules and exceptions applicable to foreign investment in Mexico. Therefore, it is important to seek legal advice from a Mexican attorney regarding potential implications of FIL regulations.
1. Mexican Corporations ("S.A. de C.V." or "S.A.P.I. de C.V.")
Corporations in Mexico are incorporated by shareholders (accionistas) whose liabilities are limited to the amount of their paid shares. In corporations, capital stock is represented by shares. Share certificates are commercial notes that can be transferred by simple endorsement. In practice, corporations are usually incorporated with variable capital, which means that the company can increase or reduce its issued and outstanding capital stock (other than the minimum fixed capital) without amending its by-laws.
Upon incorporation, a corporation must have fully subscribed its capital stock, with an amount determined by the shareholders in the corporation's by-laws (minimum fixed capital). A corporation must have at least two shareholders to be incorporated, which may be Mexican and/or foreign individuals or entities.
Corporations must keep a shares registry book containing each shareholder's name, address, nationality, Tax ID, and the amount of shares owned. Any transfers of shares must also be recorded in such share shares registry book. Pursuant to the Mexican General Law of Business Organizations ("GLBO"), the company will consider as owner of the company's shares, whoever is recorded in such shares registry book.
The corporation's management may be vested in one ("Sole Administrator") or more directors ("Board of Directors"). Whenever two or more directors manage a corporation, they must act as a Board of Directors. If the Board of Directors has three or more members, the individual shareholder or group of shareholders owning 25% or more of the corporation's capital stock has the right to appoint at least one member of the Board of Directors. The corporation will be legally represented by the Sole Administrator or Board of Directors, and its authority will be contained in the corporation's by-laws.
The corporation's Sole Administrator, Board of Directors, or shareholders will be vested with the authority to appoint one or more directors, such as a CEO, which appointments may be revoked at any time by the corporation's Sole Administrator, Board of Directors, or by the shareholders.
To protect shareholder interests, the GLBO mandates the appointment of one or more statutory examiners (comisarios) directly by the shareholders. Their main rights and obligations include presenting an annual report to the Shareholders' Meeting, addressing the truthfulness, adequacy, and reasonableness of the information of the corporation presented by the Sole Administrator or Board of Directors to the Shareholders' Meeting.
2. Mexican Limited Liability Companies ("S. de R.L. de C.V.")
Limited liability companies are formed by partners (socios) whose liabilities are limited to the extent of their paid contributions. Unlike a corporation, each partner's contributions are represented by a single equity quota, which is not considered a commercial note. Transfer of equity quotas and admission of new partners are limited in this type of companies.
Same as corporations, limited liability companies in Mexico are usually incorporated with variable capital.
For incorporation, a limited liability company must have fully subscribed capital with at least two equity quotas valued no lower than MXN $1.00 each (minimum fixed capital), as provided by the partners in the company's by-laws. The assignment of equity quotas, as well as the admission of new members, requires a prior favorable approval of the majority of the partners, unless the company's by-laws provide a higher threshold.
Limited liability companies must also keep a partners' registry book, in which the name, address, nationality, Tax ID, and the amount of each equity quota of all partners must be registered. Any transfers of equity quotas must be registered in such partners' registry book. Pursuant to the GLBO, the company shall consider as owner of the equity quotas whoever is recorded in such partners' registry book.
GLBO requires at least two partners to incorporate a limited liability company, with a limit of 50 partners. The GLBO allows the partners of any given limited liability company to be either Mexican and/or foreign individuals or entities.
The limited liability company's management may be vested in one ("Sole Manager") or more managers ("Board of Managers"), who can be freely removed by the company's partners at any time. Whenever two or more individuals are entrusted with the management of the company, they must act as a Board of Managers. The company will be legally represented by its Sole Manager or its Board of Managers, and its authority will be provided in the company's by-laws.
The limited liability company's Sole Manager, Board of Managers, or partners will be vested with the authority to appoint one or more directors, such as a CEO, which appointments may be revoked at any time by the limited liability company's Sole Manager, Board of Managers, or partners.
Unlike a corporation, the appointment of statutory examiners is not mandatory in limited liability companies.
1. Overview
According to the World Economic Forum's Global Competitiveness Index ("WEF"), Mexico ranks second in Latin America in competitiveness. For decades, a good number of foreign companies have established themselves in Mexico. These large corporations trust Mexico as a safe destination for investment, while favoring the national economy with their businesses.
2024 will be an interesting year for Mexico, as President Andres Manuel Lopez Obrador's administration comes to an end. The new administration will most likely bring changes to various areas of the Mexican economy, which may bring new business opportunities for investors, but also new rules that will have to be reviewed to better capitalize on the opportunities in the new political environment.
A topic of great interest at the moment is the "nearshoring" commercial, economic and legal phenomenon, which in the last years has been presented by the moving of the facilities of many industries and manufacturing companies from abroad to locate them in areas closer to the United States. The nearshoring trend is a huge opportunity for such companies that has directly increased Mexico's manufacturing sector, positioning Mexico as a key player in North America's supply chain.
2. Mexico's Tax System
Mexico has a residence-based system under which an individual residing in the country for tax purposes is subject to taxation over his worldwide income.
For tax purposes, foreigners are individuals or legal entities that are governed by the legislation of another country for reasons of nationality, domicile, residence, place of operation, among other criteria.
Legal entities (such as LLCs, corporations, partnerships, associations, among others) that have not established in Mexico the main place of their business, or their effective place of management are considered to be foreign residents.
Legal entities that are foreign residents must pay taxes in Mexico, i) when they obtain income from any source of wealth located in Mexico or ii) when they have a permanent establishment ("PE") in Mexico, for the income derived from such establishment.
Mexico has both federal taxes (income tax, import taxes and duties, value added tax ("VAT"), and social security contributions, among others) and some state and local taxes (such as the tax on acquisition of real estate, property taxes, and payroll taxes).
3. Income Tax
In general terms, the subjects to income tax are: i) Mexican residents —individuals or legal entities—, over their worldwide income, ii) Non-residents with a PE in Mexican territory, over the income attributable to such PE, and iii) Non-residents without a PE in national territory, over their income with a Mexican source of wealth.
The income tax's object is the income obtained by the taxpayer during a fiscal year. The Income Tax Law ("ITL") does not provide a general definition of "income"; however, in the context of ITL, Mexican courts have defined it as a "positive modification registered in the patrimony of a person which is susceptible of pecuniary valuation."
The base on which the income tax is calculated is determined on the income of the entity less the deductible costs required to produce such income. The general maximum rate is 30%.
The business expenses of a company will be deductible if they are properly documented, strictly essential for the purposes of its business and supported by relevant invoices. Furthermore, there are specific requirements for each type of deduction.
Taxpayers are required to make advance payments of income tax on the 17th day of each month; such advance payments should be made in the basis of an estimated annual taxable income. Advance payments are not required during the first year of operation of a business.
4. Value added tax (VAT)
VAT is levied on the transfer of goods, the provision of services, the import of goods or services and leasing transactions. Interest on non-business loans is also subject to VAT.
VAT is calculated by applying the corresponding tax rate to the values set forth in each case. As a general rule, a 16% tax rate will be applied. A 0% rate will be applied to exports and services used abroad if the services are contracted and paid for by a nonresident without a PE in Mexico.
Generally, VAT's basis is the consideration effectively collected. However, when there is no consideration paid in cash, goods or services, the appraisal value or current market value of the goods or services will be deemed as the tax basis.
VAT is triggered when the consideration corresponding to the goods and services is effectively collected or when the goods are imported. VAT Law provides as a rule that consideration will be deemed as effectively collected, when they are received in cash, goods or services, or when creditor's interest is satisfied through any form by which obligations are legally extinguished —such as an offset, novation, among others—.
A sale shall be deemed performed in national territory if the assets are located in Mexico when they are sent to the buyer or when the material delivery takes place in Mexico.
VAT Law allows taxpayers to apply as a credit, the value added tax that was transferred to them by third parties (and the one paid on the import of goods or services) against their own tax, in order to determine the payable value added tax (triggered tax larger than the transferred or paid on imports) or value added tax in their favor (transferred tax or paid on imports larger than the triggered) during the corresponding taxable period.
Value added tax is assessed on a monthly basis, same which must be definitively paid through a monthly tax return.
5. General tax obligations
Companies or organizations that are foreign residents with or without a PE in Mexico must register and obtain their Federal Taxpayers Registry (RFC) and file a request before the SAT after incorporation to obtain their Electronic Signature Certificate (e.firma);
Monthly provisional income tax returns and monthly payment of VAT;
Annual tax return. Annual tax return related to the prior fiscal year must be filed with the tax authorities by no later than March 31st of each year;
Statement of transactions with third parties ("DIOT");
Electronic invoices. Local invoices need to be electronic and meet the requirements set forth in the applicable tax laws;
Upload the accounting documents to the tax authority's system on a monthly basis.
6. Tax consequences for foreign shareholders of Mexican Subsidiaries
Mexican entities that make payments to foreign entities or individuals are required to withhold and pay the tax before the tax authorities on behalf of the recipient. Tax withheld generally must be paid by the 17th day of the month following the month of the withholding.
Dividend distribution for Mexican Subsidiaries
In case that the dividend is paid to foreign residents it will be subject to an additional 10% withholding rate is applicable.
The Tax Treaty to Avoid Double Taxation executed between Mexico and China establish a preferential 5% withholding rate upon any profit or dividend distribution sourced in Mexico.
It is required to evidence (through a tax residency certificate) that the foreign shareholders are residents in China, and that are entitled to claim the benefits of the Treaty.
Capital gains
The eventual sale of the shares of Mexican Subsidiaries will trigger a tax of 25% on the net gain or 35% on the gross amount if the nonresident has a representative in Mexico. A tax return relating to the sale must be filed and a fiscal opinion obtained from a Mexican public accountant certifying that the reported gain is calculated correctly.
Interest
If a foreign shareholder granted a loan to the Mexican Subsidiaries, interest is considered to be sourced in Mexico where the capital is placed or invested in Mexico or where the party paying the interest is a Mexican resident or a non-resident with a permanent establishment.
Interest paid to a nonresident is subject to withholding tax at rates ranging from 4.9% to 35%.
Under thin capitalization rules, interest paid by a Mexican resident to a nonresident related party are non-deductible for income tax purposes to the extent the amount of debt exceeds 3 times the equity of the Mexican subsidiaries. (The thin capitalization rules only apply in transactions between related parties).
Royalties
Payments made abroad for technical assistance, know-how, use of models, plans, formulae and similar technology transfer, including use of commercial, industrial or scientific information or equipment are considered royalties for purposes of the ITL.
Royalties paid to non-Mexican residents are deemed Mexican sourced when the payer is a Mexican resident for tax purposes. A 25% income tax withholding rate on the gross amount of the transaction would be applicable, —unless the rate is reduced under an applicable tax treaty—.
Payments carried out by a Mexican company to foreign shareholders for the right to use a brand or technology would be considered royalties for income tax purposes and, on a general basis, the former would have to withhold the corresponding income tax.
As of 2022, the concept of royalties has included the right to an image, specifying that for such purposes this right implies the use or concession of use of a copyright on a literary, artistic or scientific work.
Know how
For purposes of ITL, the term "know how" refers to the transfer of confidential information regarding industrial, commercial or scientific experience.
The Commentaries of the Organization for Economic Cooperation and Development ("OECD") to Article 12 of the Model Tax Convention, add that "know how" refers to the transfer of undisclosed not patented information arising from previous experience, which has been practical application in the operation of an enterprise and from the disclosure of which an economic benefit can be derived.
Under such scenario, the payments derived from such transfer would be considered as royalties subject to a 25% income tax rate. However, a preferential income tax rate provided in the Tax Treaties could be applied.
Technical Assistance Services
The foreign shareholders of Mexican Subsidiaries could render certain specialized services in favor of the Mexican Subsidiaries or its clients. In a service agreement, the essential element is the assumption of a performing obligation by the renderer of the service before another party (its client), in exchange for a certain consideration. In general terms, the rendering of services may be of two kinds: (a) rendering of services in a broad sense, and (b) services that imply a technical assistance.
Prior to the Tax Reform of 2022, the deduction of payments for technical assistance, technology transfer or royalties made to residents in Mexico was allowed, provided that in the contract it was agreed that the services would be rendered by an authorized third party.
However, this exception was eliminated, so that such payments can only be deductible when they are made to residents in Mexico, in which the contract has agreed that they are specialized services or execution of specialized works.
Due compliance with labor legal framework is crucial for the success of any company operating in Mexico. After incorporating a Mexican entity or successfully setting up an establishment for a foreign entity in the country any company must be mindful of several particularities of Mexican labor law to ensure compliance with it. Maintaining labor relations in compliance with applicable legal framework is key to achieving companies' goals and seeking continues improvement in the organizational climate and results.
Mexican labor legislation incorporates a series of provisions that seek to protect workers' rights. Appropriate legal advice and compliance with labor law provisions is relevant for the success of any company doing business in Mexico. Preventing and adequately managing present or future risks substantially reduces potential non-compliance with labor regulations, which could eventually lead to sanctions by competent authorities, or to lawsuits filed by members of the workforce.
Therefore, with the purpose of implementing startup mechanisms and systems that minimize or eliminate any risk and ensure proper compliance with the applicable legal framework, any company shall bear in mind -primarily- the following considerations:
1. Obtaining employer records from competent authorities
Before beginning any hiring process in Mexico and formally register any employees, companies must first register as an employer with certain government authorities, such as the Mexican Social Security Institute (IMSS) and the National Workers Housing Fund Institute (INFONAVIT). Moreover, registration with the Tax Administration Service (SAT) is also relevant for withholding tax payments.
2. Implementation of an adequate recruitment process
When a company wishes to initiate the recruitment process of employees, in addition to labor law it must consider provisions relating to privacy and data protection regulations, among other complementary legal requirements. It is recommended that a company develop detailed work profiles of the skills and job responsibilities, including candidate's qualifications. Moreover, during the selection process a company must keep in mind the ample antidiscrimination protections that are enforced in Mexico, such as discriminating based on ethnic or national origin, gender, age, disabilities, among others that may violate human dignity. Additionally, data protection regulations mandate that any entity that engages in the treatment of data or information from any individual (baring some exceptions) must make available a privacy notice, including information collected from job applicants and employees. In addition, if employers wish to condition the validity of an offer to any background checks, they must also include said disclaimer in the corresponding job posting or offer of employment and must also acquire consent from any candidate prior to initiating a background investigation.
3. Employment Contracting Schemes
Employers have various employment schemes recognized by Mexican labor law at their disposal. Besides "ordinary" employees, Mexican law establishes various employee types that may be hired by a company, some of these include: (i) confidence employees, (ii) special employees, (iii) minors, (iv) unionized employees, and (v) foreigners. Each employment type incorporates distinct legal protections and obligations for both the employee and employer. Confidence employees involve management, inspection, monitoring, and supervision functions. Special employees relate to industries specifically and individually regulated by Mexican Labor Law (such as the maritime industry, the air transport industry, railway workers, the land transportation industry, etc.). Minors also have ample legal protections and employers are subject to certain limitations, particularly with relation to a minor's work schedule. Unionized employees imply the execution of a collective bargaining agreement by the company and the corresponding union. Foreigners while basically subject to the same legal treatment as ordinary employees are also subject to various restrictions, including restrictions relating to job roles they may be hired for and specific industries in which they may or may not work (as well as quotas which employers may not exceed).
Furthermore, parties may enter various contract types depending on the nature of the work required. Different contract types include: (i) for an indefinite time period (default contract type in Mexico), (ii) for specific work (only when the nature of the work requires said contract type), (iii) for a definitive time period (only when expressly allowed by law, when temporarily substituting an employee or when the nature of the work requires it), (iv) seasonal employment, and (v) remote workers (when employees engage in remote work for more than 40% of their ordinary work schedule). Regarding remote work -increasingly common- remote workers are subject to the same rights and obligations as ordinary workers, however, employer is mandated to develop a remote work policy and issue a health and safety questionnaire to ensure that the remote workplace complies with health and safety requirements.
4. Trial and Training Periods
Depending on the nature of the work, employers may include a trial or training period in an employee's training contract. Said trial period does not release the employer from covering social security contributions and complying with the rest of applicable obligations. The trial period is capped at a 30-day maximum (or 180 days for confidence employees), while the training period is capped at 3 months (or 6 months for confidence employees). If an employee does not meet the expectations or qualifications necessary for his role, employment may be terminated without liability for the employer as long as he provides proper notice before the end of the trial or training period with the appropriate justification.
5. Outsourcing
Mexican labor law prohibits the practice of outsourcing or subcontracting employees with the exception that the company hires specialized service providers for work not overseen by its corporate purpose or that is not companies' preponderant economic activity. When hiring a specialized service provider companies must bear in mind that such provider must be registered in the database established by the labor authorities. Furthermore, a distinct set of legal obligations is applicable to companies who hire specialized service providers, such as those relating to contractual stipulations, joint liability for social security contributions, and specific tax law regulations.
6. Basic legal obligations as an employer
Wages.
All employees in Mexico must receive at least a minimum wage as salary. Said minimum wage is set by the National Minimum Wage Commission and may vary depending on the geographic area. Moreover, the minimum wage is periodically updated to reflect inflation. While minimum wage increases are usually mandated on an annual basis, an increase may be mandated at shorter intervals if the country is experiencing high inflation. Certain jobs may be subject to a different minimum wage (mostly professionals or special workers). Employees are also entitled to an annual bonus (Christmas Bonus) of not less than fifteen days' wages, payable on or before December 20.
Vacations.
Applicable provisions grant employees the right to paid vacations after one full year of employment, which may not be inferior to twelve continuous workdays and increases by two days for every year of employment. After employees accrue a right to 20 days of vacation (5 years of employment), vacation days will increase by 2 days for every additional 5 years of service. In addition, employers shall pay a vacation premium which may not be less than 25% of the daily salary per day of vacation.
Housing Fund and Retirement Savings Fund.
Employers must contribute 5% of the payroll to the National Employees' Housing Fund Institute (INFONAVIT), and 2% of the payroll (bimonthly), to the Retirement Savings Fund.
Social Security.
Employers are mandated to enroll their employees before IMSS and must withhold and pay contributions. Applicable regulations establish the percentages that must be contributed by both the employer and the employee.
Profit Sharing.
Mexican labor law grants employees the right to participate in their employer's profits. Therefore, profit sharing is mandated for all business except in the case of newly established companies during their first year of operation or newly established companies engaged in the manufacturing of a new product during the first two years of operations. The percentage of profits that are subject to profit sharing are set by the National Commission on Profit Sharing and are currently at 10% of taxable income. Profit sharing is capped at 3 months of salary, or the average sum received as profit-sharing during the last 3 years (whichever criteria is more beneficial for the employee).
Compliance with labor obligations is key to the success and prosperity of any business plan. Having permanent legal advice in this field will give employers the certainties they need to fully comply with all their duties and focus on the consolidation of their projects.
Mexico is organized as a Federal Republic and has 3 different levels of government: Federal, State and Municipal. Regarding the judicial field, disputes can be brought before state or federal courts.
Appearing before a state or a federal court and/or apply state or federal laws will mainly depend on the (i) type and nature of the dispute and the (ii) court jurisdiction. Nonetheless, commercial disputes -which represent a very important number of cases- can be managed indistinctly by state and federal courts.
Mexico has several ways and mechanisms for managing and solving a dispute. Each alternative will depend on the type and nature of the dispute, its complexity, monetary value, guarantee schemes, among other circumstances. Some common disputes include real estate, shareholder disputes, collateral enforcement, enforcement of credit instruments, breach/termination of contracts and enforcement, collections, claims for damages, product liability, insurance and bond claims, force majeure claims, banking, insolvency, bankruptcy, labor, tax, regulatory law, criminal law, family law, enforcement of arbitration awards, alternative dispute resolution procedures, among others.
In general terms, the main choices to solve a dispute in Mexico is through litigation or alternative dispute resolution mechanisms. Below we will refer to some distinctive elements of each of them, including some relevant aspects related to the enforcement in Mexico of foreign judgements.
1. Litigation
As noted previously, the type of litigation or action will depend on the nature of the dispute and several factors. However, procedures in Mexico generally follow the same essential stages and due process principles, which include the (1) filing and admission of the lawsuit, (2) service of process, (3) answer to the claim by defendant, (4) evidentiary period, (5) closing arguments and (6) issue of the final judgement. Also, in some cases, it is possible to file an appeal against the final judgment, which is analyzed and solved by a court of appeals. Furthermore, the Mexican system includes a constitutional trial (Juicio de Amparo) as the last and definitive alternative for judicial challenge. By this constitutional trial federal circuit courts analyze potential violations to human rights during the trial, such as due process and due access to justice.
As mentioned before, commercial trials represent a very important and relevant number of cases in Mexico. Below we will refer to the main types of commercial trials available in the Mexican system:
a. Ordinary Commercial Trial (Juicio Ordinario Mercantil): This process follows the general and standard steps noted above, and is mainly carried out in written motions, briefs, and pleadings. Any commercial dispute that the law does not provide for a special procedure can be solved through this ordinary process. The judgement can be appealed to be solved by a court of appeals.
b. Oral Commercial Trial (Juicio Oral Mercantil): Contrary to the Ordinary Trial, the Oral Commercial Trial is mainly carried out in oral hearings, except for the lawsuit, the answer to the lawsuit and the judgement. Oral Trials are generally resolved more quickly than an Ordinary Trial. There are no appeals against the final judgement, and the decisions can only be challenged through the constitutional trial described below. Currently, oral trials are the most effective means of resolving commercial litigation disputes, and it is very common in small claims scenarios.
c. Executory Commercial Trial (Juicio Ejecutivo Mercantil): The distinctive characteristic of this procedure is that from the service of process the plaintiff is entitled to seize assets of the defendant to secure payment of the amounts claimed. This procedure can only be initiated if it is based on credit instruments and titles, such as promissory notes.
d. Constitutional Trial (Juicio de Amparo Directo): is an action in which the plaintiff alleges that their human rights were violated by the government or by a court of law. Judgements issued by ordinary courts can be challenged through the constitutional trial for violations to their rights during the procedure, or if the reasoning of the court is improper. These trials are heard by the Federal Circuit Court, which is composed of a panel of three judges.
2. Alternative dispute resolution
Mexican law provides for the following alternative dispute resolution mechanisms:
a. Conciliation and Mediation: Although this mechanism is not exclusive to Mexican legislation and several countries also provide it, in Mexico there are public mediators, who are court officials, or private mediators who are certified by the courts. The agreements entered by the parties which are also executed by public or certified private mediators and comply with certain legal requirements, will have the effect of res judicata.
b. Arbitration: Mexican law recognizes arbitration as an alternative dispute resolution mechanism, and its provisions are based on the UNCITRAL Model Law. Arbitrations can be ad hoc or institutional. The most used institutions or rules are those of the International Chamber of Commerce (ICC) and the Arbitration Center of Mexico (CAM). Awards must be enforced by a competent court. Awards cannot be appealed to state of federal court; however, it is only possible to challenge the nullity of the award.
3. Enforcement in Mexico of foreign judgements
Any foreign judgement shall be recognized as valid in Mexico unless it falls under some specific exceptions that prevent it.
Some legal requirements to enforce in Mexico a foreign judgment include: (i) the foreign judge or court has jurisdiction to hear and decide the matter in accordance with the recognized rules of international law which are consistent with those provided by Mexican Law; (ii) the judgment is not rendered as a consequence of exercising an in rem action (acción real); (iii) the service of process in the action has been made personally to defendant, thereby guaranteeing the essential rights of defense of the defendant; (iv) the judgment does not contravene public policy of Mexico, international treaties or agreements or generally accepted principles of international law binding upon Mexico; (v) the action in respect of which such judgment is rendered is not the subject matter of a lawsuit among the same parties pending before a Mexican court, or there is a judgment in Mexico regarding the same action; (vi) the courts of such foreign jurisdiction recognize the principles of reciprocity in connection with the enforcement of Mexican judgments in such foreign jurisdiction; (vii) such judgment is final in the jurisdiction where obtained.
The manufacturing sector continues to be a growing area of foreign investment in Mexico. Chinese companies are taking advantage of the nearshoring trend to access the North American market.
Below are some key legal considerations.
1. Shelter Agreements versus Direct Manufacturing
The first decision for manufacturing in Mexico is whether the company will use a shelter arrangement or open a wholly owned manufacturing company.
Under a shelter agreement, a Mexican Shelter Company, holding the permits and authorizations to import/export, hosts the operation of foreign manufacturing companies and assists with recruiting, hiring and management of operations. The Shelter Company leases the required facilities on behalf of its foreign manufacturing clients, handles the import/export permits and paperwork, and provides administrative support. Shelter companies provide these services for a fee, which is usually a percentage of the payroll costs.
Foreign companies may alternatively decide to invest directly in Mexico by setting up an entity, hiring employees, leasing the facilities, and getting all of the permits to do the manufacturing for purposes of exporting the final product outside of Mexico.
There are pros and cons for each approach. Shelter arrangements tend to be faster to start operations and may somewhat be a soft landing to start operations in country, but they add additional costs. Direct manufacturing takes longer to start operations because it requires to obtain the permits first. It also has a higher learning curve than shelter arrangements because foreign manufacturing companies need to understand and manage Mexico operations directly.
Many companies begin operations with shelter arrangements and after sometime migrate to a direct manufacturing scheme.
2. Leasing or Buying Facilities
Many foreign companies looking to expand their manufacturing operations in Mexico seek to do it in industrial parks by leasing facilities, acquiring existing facilities already built, or land to build their own facilities. There are many industrial parks in Mexico. Industrial parks usually provide the advantage of having infrastructure and services readily available for manufacturing.
Other companies establish their operations outside of industrial parks. In both cases, it is advisable to do a comprehensive due diligence, including environmental, title and regulatory matters. There is a special legal regime for certain properties owned by farmers called "Ejido". Ejido land is subject to strict transfer restrictions. If a land has an Ejido background, it is required to do an extensive due diligence to mitigate title risks in the future.
3. Location
Location is also an important factor to develop manufacturing operations. Although there are manufacturing facilities spread out all over the country, the largest clusters tend to be in Central and North part of Mexico. It is always important to consider the availability of adequate infrastructure for each project, including access to national highways, ports, and airports. Physical and legal access to water, power and infrastructure in general are very important.
4. Labor Laws
Mexico has a pro-employee legislation. In general, employment agreements are for indefinite period of time and can only be terminated for just cause. Termination of employment without just cause requires the payment of statutory severance. Employment agreements must be in writing and must specify the main terms and conditions of the labor relationship. It is critical to have robust employment agreements in place.
There is also a mandatory 10% profit sharing subject to a CAP. General outsourcing is prohibited but companies may hire third-party specialized services subject to certain requirements. Finally, some industries are heavily unionized, for example mining. Unionization varies by industry and State. There are unions with national presence while others have local presence only.
5. Access to Markets
The U.S., Mexico and Canada are parties to the U.S-Mexico-Canada Agreement (USMCA) which entered into force on July 1, 2020, replacing the North American Free Trade Agreement (NAFTA). According to the USMCA, goods and services that qualify under the agreement have zero tariffs in the North American region.
In addition, Mexico is a member of the World Trade Organization, the Organization for Economic Cooperation and Development, the Asia-Pacific Economic Cooperation, and the Group of 20. Mexico also has 13 Free Trade Agreements with 50 countries, including with the European Union, European Free Trade Area, Israel, Japan, 10 countries in Latin America, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, and the USMCA. Mexico is also a member of the Pacific Alliance.
These free trade agreements provide an extensive market access around the world.
Mexico has double taxation treaties with 60 countries, including with China. These treaties reduce or eliminate tax withholding from non-Mexican residents.
Mexico has 50 licensed commercial banks and three government development banks focused on commercial activities. The financial system also includes other lending institutions such as e-banks, sofoms (non-bank credit companies), fintechs and other venture capital funds, but the core business for corporate loans and commercial lending is performed by traditional commercial banks.
There are no currency restrictions and banks can freely perform exchange rate currency transactions. The most typical loan transactions are done in the local currency, Mexican pesos, and in U.S. dollars.
The banking industry in Mexico continues to be formalistic although most commercial banks have adopted internal policies that are moving to a more flexible standard when it comes to electronic documents and technology. But the legal due diligence process and the "know your customer" policy involved in any corporate banking transaction is a formal and standard procedure in most cases, which all clients must face with a certain level of complexity when going through a credit authorization process within a financial institution, and specifically for companies that are newcomers as clients for such banks.
In general, the process for any company to borrow money can be broken down into three stages. The first is the business case analysis conducted by the bank through its commercial division (these working groups can be divided into specific areas of business or industry such as transport, energy, tourism, industrial real estate, infrastructure or corporate). The second is the legal structure and implementation in which the drafting of contracts and due diligence of the potential borrower is conducted by the internal legal division of the bank, and in some occasions together with the bank's external counsel (law firms specialized in finance and commercial transactions). The third is the signature of the financing contracts and the preparation of the loan disbursement until its final withdrawal.
Typically, these three main stages of a financing project are completed in three months. The timeline depends on the level of sophistication of the transaction and whether it presents complex due diligence challenges, especially when the financing entails an asset guarantee portfolio such as real estate, machinery or equipment, assignment of rights over contracts of a specific project (including collection rights), inventory or other unique assets such as ships and aircraft.
Stage 1. The Business Case.
A good relationship with a banker is key for any financing transaction. It all starts with the preparation of a business case in which the borrowing company presents its credentials in the form of a brochure or prospectus, together with audited financial statements (mostly in conformity with GAAP principles) showing solid creditworthiness and sufficient equity investment from its stockholders. Identifying the client for purposes of internal policy will be required and several "know your customer" bank forms and related documents will need to be submitted as part of the procedure. Mexican law requires banks to identify the beneficial ownership of any borrowing company and gather sufficient information, data and documents to complete an anti-money laundering AML filing as a matter of public policy.
Identifying the purpose of the loan will be of upmost importance to align the business interests of the borrower with those of the bank, specifically if the purpose of the loan may qualify within a specific program that the bank may have, such as corporate, export, acquisition, manufacturing, and other purposes for the development of specialized industries as mentioned above.
Also, the bank will consider what will be the payment source of the loan in terms of the bankability of the project. Every credit study and business case must have a payment support structure showing how the company will repay the debt through a source of income that will be compromised in favor of the bank during the term of the financing and under a safe coverage of a debt service coverage ratio which may vary from 1.30 to 1.50 depending on the risk.
Most corporate loans are structured as secured facilities rather than unsecured, and may take the form of asset acquisitions, working capital, revolving or term loan facilities.
The taking of security will depend on the level of risk exposure and also to the nature of the project. A structured finance will naturally follow a direct guarantee of the underlying asset for which the proceeds of the loan will be used (a typical asset acquisition), plus any other guarantee over an asset that the company may propose to the bank in sufficient value to reach a reasonable coverage ratio between 1.5:1.00 and 2.00:1.00.
Typical security interests under Mexican law include: (i) a mortgage, (ii) a pledge, and (iii) a guarantee trust. Also, it is common for guarantors and obligors to join the loan structure, either from its origin or thereafter.
After the business case (including the credit study showing the bankability of the project) has been completed between the banker and the borrowing company, the matter is ready for the credit committee approval. A solid and businesswise case will give higher assurances for credit committee authorizations, but in some cases the credit committee may find the need to reject, suspend or return a business case until better conditions are met, at its discretion.
Stage 2. Due diligence and drafting of the financing documents.
Once the terms and conditions of the financing have been established by the bank – typically in the form of a term sheet delivered to the borrower – then the heavy lift of drafting the loan documents begins. This task is performed by the bank's internal legal team, and on some occasions, they will entrust to external counsel (law firms) specialized in finance transactions.
Typically, the bank will use its own institutional templates, which include standard language for these types of transactions based on banking practice and internal bank policy. Some transactions may be heavily negotiated in reason of their complexity in their structure (i.e. project finance), but others may develop smoothly as the conditions of the loan agreement and their guaranty documents will normally contain reasonable terms under both national and international financial practice (such as reps & warranties, conditions for disbursement, covenants and events of default).
This stage will encompass a multiple exchange of loan document drafts between the bank, the borrower and each of their counsel. Comments will be made, and the loan documents will be negotiated among the parties until a final draft is agreed.
At the same time, a legal due diligence process will be performed by external counsel on the borrower, the assets subject matter of the secured structure and the project documents comprising the source of payment of the loan. A due diligence report will be prepared and submitted to the bank prior to closing. The main features of this report are to confirm that the borrower has the legal authority to enter into the loan and guarantee documents in terms of its corporate purpose and any special corporate resolution required in its bylaws. The due diligence will also include the review that the individuals acting as signatories for the borrower or guarantor in the financing documents, do have sufficient authority to do so under Mexican law (the common authorities/faculties that are required are power of attorney for acts of administration and acts of ownership). It is important to confirm that no prior liens or claims exist against the borrower, its assets, and specifically the assets subject matter of the guaranty structure. Any underlying contracts from the borrower that may serve as source of payment of the loan will be reviewed to confirm that the collection rights may be assigned in favor of creditors and if any notice or pre-authorization is required under such contract. For secured transactions involving real estate property, obtaining a non-lien certificate and a preventive notice to set priority will be required.
Stage 3. Signature and disbursement of loans.
Once the due diligence is successfully concluded and the loan documents have been agreed in final form then the parties are ready to sign the contracts.
The loan documents will follow special legal form. The loan agreement and the guarantee documents will normally be either formalized in a public deed or ratified by the parties, both with a notary public. This formality creates legal assurance and access to the Public Registry of Property and Commerce for the registration of the security interests in favor of the bank, creating preference and priority against third parties.
The bank and the borrower will work on satisfying all agreed conditions precedent for disbursement, same which may take place after the signature of the loan documents, normally within the next three to five days from closing.
Once all conditions are met, the bank will disburse the money to the borrower.
Bank debt continues to be an attractive option for companies in Mexico for obtaining cash liquidity as an alternative for capital investment. We anticipate seeing significant growth in bank corporate loan placements within the next 12 months by both Mexican private commercial banks and government development banks. As a benchmark the annual interest rate for a corporate loan is 11%.
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Haynes and Boone, LLP. Shanghai Representative Office (hereinafter referred to as the "Shanghai Office") provides legal services to clients throughout Asia, including China, India, Japan, Singapore and South Korea. We have extensive experience with clients doing business in Asia and with Asian companies entering the U.S. and global markets, with nearly 700 lawyers and more than 40 practice areas across 19 offices on three continents, focusing on energy, technology, financial services and private equity. We understand how business operates in Asia and its culture and customs. Our Asian practice focuses on providing a full range of domestic and cross-border legal services.
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Haynes and Boone has shown itself to be one of the most active U.S. law firms operating in Mexico with a growing list of both international and Mexican clients. Operating in Mexico City with its affiliate, Haynes and Boone, SC, it is among the largest U.S. firms in Mexico and has been serving clients in both Mexico and the U.S. for 20 years. Its fully bilingual and bi-cultural Mexico City office has legal professionals licensed in both Mexico and the U.S. and trained in both legal systems.
The firm has experience in a wide variety of Mexican business sectors. Our strong presence in Mexico is grounded in our extensive network of contacts in Mexican government, media and business. Our legal professionals in the Mexico City office are highly experienced in cross-border and domestic transactions in practice areas including corporate; banking and finance; real estate; energy; hospitality; international and domestic tax matters and planning; litigation and arbitration; project development and finance; and transportation.