Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

Put and Call Option Agreement (Mexico): Checklist

by Juan Francisco Torres Landa and Andrea López de la Campa, Hogan Lovells, Mexico City

Checklists | Law stated as of 01-Jun-2022 | Mexico

A checklist of the key considerations when drafting a put and call option agreement to make it compliant with
Mexican law. Key considerations include the option exercise period, exercise price, restrictions on transfer, anti-
dilution mechanisms, and other typical features of a put option and call option agreement in respect of shares in
non-listed public and private companies in Mexico.

This Checklist sets out the key issues to consider when tailoring a put option and call option agreement in respect of shares in
non-listed public and private companies to make it compliant with Mexican law.

It provides background commentary in relation to issues of Mexican law that may impact Standard Document, Put and Call
Option Agreement: Cross-Border. Where clauses in this Standard Document need to be amended to comply with Mexican law,
suggested drafting is provided.

What Are Put or Call Options?

Although no formal legal definition exists, a right to purchase, or a call option, is generally understood to be a right (but not an
obligation) for its owner to purchase assets for a fixed or indefinite period, usually at a predetermined price.

Conversely, a right of sale, or a put option, is considered a right (but not an obligation) for the owner to sell assets for a fixed
or indefinite period, usually at a predetermined price.

An option is deemed a binding offer to purchase or sell. Usually, the purchase or sale is effected by a single statement from
the owner. Subject to contractual requirements, the statement may have to be in writing. Apart from issuing this statement,
there is nothing further the owner of an option must do to exercise their option rights. Depending on the contractual provisions,
following the exercise of the option right, a separate purchase agreement may need to be concluded between the parties to
effect the purchase or sale.

The option is freely transferable unless limitations on transferability apply (see Transfers to Third Parties).

Option Exercise Period

There are no mandatory provisions under Mexican law that would either set a specific timeframe for an option to be exercised
or require it to be exercised within a reasonable period of time. There is no legal interpretation of "reasonable time."

It would be customary to include in the option agreement a timeframe during which the option may be exercised. If no specific
timeframe is set out, it would be standard to provide that the option may be exercised subject to the satisfactory fulfilment
or waiver of a previously agreed set of conditions (that is, conditions precedent). While it would not be illegal, it would not
be recommended to include an "open-ended" option whereby the buyer would be entitled to exercise the option at any time
after closing. Alternatives may be put in place, such as a duty to provide notice of execution of the option or non-execution
or extension at specific points in time as of closing.

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Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

Acceleration Events

In Mexico, it is common to provide that, in case of an actual or expected change of control of the issuer (such as third-party
takeover, initial public offering or other exit event relating to existing shareholders (for example, a trade sale), either the option
holder could accelerate the option, or the seller would require consent from the buyer before proceeding with a change in control.

Such a change in control could constitute a material adverse event, entitling the buyer to:

• Terminate the agreement with prejudice.

• Enforce a right of first refusal, if any (the buyer would need to at least match the third-party offer).

• Come to some other agreement with the seller.

However, in these circumstances, a put and call option holder would typically have its options accelerated so that it may become
a shareholder immediately before the exit event and participate in the relevant transaction.

Consideration for the Grant of a Call or Put Option

Under Mexican law, consideration is not required to be able to grant a call or put option. However, an agreement referring to
call or put options must contain rights and obligations for both parties to be valid; unilateral agreements are valid under Mexican
law, but not for these types of transactions. Should the contracting parties belong to the same corporate group or be otherwise
related, then transfer pricing rules would apply.

The only consideration to be paid when the option is being exercised by the option holder relates to tax. However, non-related
parties acting on an arms-length basis might not be strictly required to include a consideration and would be taxed as if a market
consideration had been in place. It is recommended to seek advice from a local tax counsel in connection with any tax issues
before entering into a transaction. For taxation purposes, the usual taxation laws will apply on the exercise of a put or call
option (that is, income generated from the exercise of a put option, for example, may be considered as profit originating from
a transfer, and would be treated as such by the Mexican tax authorities). Such rules are provided in tax regulations, including
the Income Tax Law.

Determination of Exercise Price

There are no written rules on how shares should be valued. Although "fair market value" is generally considered in Mexico
as an acceptable calculation method, it is recommended to avoid using this term unless the parties have agreed to a formula
for calculating it, to avoid conflicting "post-facto" interpretations of what "fair market value" meant at the time of execution
or closing of the relevant transaction.

From a contractual certainty perspective, if fair market value is the agreed pricing mechanism, then the pricing provisions usually
provide for fair market value to be determined by an independent valuer approved and appointed in advance by the parties
(or, in the event of a dispute, appointed by an independent third party, for example, the President of the Institute of Chartered
Accounts in Mexico). The agreement will then specify the valuation criteria to be applied by the valuer and the timeframes and
valuation process. If shares are liquid and freely tradeable (for example, on a registered stock exchange), then the consideration
payable may be determined by reference to the volume weighted average price (VWAP) of the shares trading on-market.

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Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

It is common and recommended to use a set baseline to perform calculations, including the earnings before interest, taxes,
depreciation, and amortisation (EBITDA) of the issuing company and the book value of its assets.

Exercise Price Set at Fair Market Value

As it may be difficult to anticipate the exercise price, parties may agree to fix it at the fair market value of the shares at the
date of the exercise of the option. The "fair market value" is the price at which a willing seller would sell and a willing buyer
would buy in an arm's length transaction, without time constraints, motivated by normal business considerations. It may be
determined by reference to the financial results of the company based on its financial statements at a given date. The parties may
agree to adjust these results, taking into consideration certain elements which affect the value of the shares, including assets
and liabilities of the company, current litigation, and so on.

Independent Determination

It is standard practice in Mexico to include provisions stating that any dispute regarding the consideration could be subject
to referral to an independent expert. These provisions would usually be negotiated by the parties to avoid the possibility of a
biased "independent" expert, and will depend on the sophistication of the contract, the experience of the parties and the value
of the envisaged transaction. It is generally advised that the third-party expert only reviews the correct application of the agreed
calculation process and that the formula is not evidently incorrect and such person should not be allowed to comment on how
the price process should have been determined and obtained.

In addition, it is common for the parties to agree on a list of external third-party accountants or financial experts that would be
acceptable to act as an independent expert. This should exclude firms that have rendered services to either party at any point
during the past two years.

General disputes are often referred to arbitration to be decided under Mexican arbitration rules (Centro de Arbitraje de Mexico)
(CAM) or preferred international rules with an arbitration forum based in Mexico.

Should the parties fail to agree on an independent expert, the choice of expert will be taken to a court or to arbitration, depending
on how the agreement regulates any disagreement between the parties. Another option is for each party to select an independent
expert. In this case, the independent experts selected by the parties will either:

• Agree on a final and binding outcome.

• Provide their calculations to their principals.

Depending on the difference between the calculations provided by the experts, and on the details of the relevant clause in the
option agreement, the lowest of the two calculations may be deemed to be the applicable consideration, although this is also
subject to being negotiated and adjusted to suit the particularities of the transaction.

It is possible, but uncommon, to provide for the consequences of the company reorganisation in an option agreement. It is
most common for the seller to be barred from undertaking any reorganisation during the call period without the express written
consent of the buyer.

There will usually be valuation guidelines agreed in the option agreement, which the appointed expert will apply to determine
the option pricing. Examples of these guidelines may include:

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Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

• The valuation standards, methodology, practices and principles generally accepted in the relevant industry for the
purposes of determining the fair market value.

• For shares in a company:

• the then existing assets and operations of the company; and

• that no control premium or minority discount should apply (that is, no consideration should be given to the size
and stake of the shares).

• For shares listed on a stock exchange, the average price of the stock over a certain number of days.

• Any other relevant valuation method customary in the industry of which the company operates.

The independent expert is usually required to give its determination within a set timeframe (for example, within 30 days).

Often accompanying the dispute resolution clause is an undertaking, given by both parties, to both assist the independent expert
by providing all information and assistance reasonably requested by the independent expert and to share the expert's costs. The
decision made by the independent expert will typically be expressed to be binding on the parties, in the absence of a manifest
error.

Consideration in the Form of Shares in the Buyer

If the consideration payable by a person who holds a call option (the buyer) is shares to be issued in that buyer, or other shares
to be transferred by that buyer on exercise of the call option, the party transferring the call option shares (the seller) should
consider obtaining the following types of warranties and representations (known as title and capacity warranties) from the buyer
in relation to the shares issued by the buyer:

• Fully paid and validly issued. That the shares are fully paid and have been validly issued by the buyer.

• Title. That the buyer is the legal and solely beneficial owner of the relevant shares (if the shares to be transferred on
exercise of the call option are issued by an entity other than the buyer).

• No third-party interest and free of encumbrances. That the shares are free from any third-party claims, rights
entitlements, options, warrants or any similar undertakings that restrict or limit either the seller's capacity to freely
acquire the shares, or the authority of the buyer to issue and transfer the shares freely and without any lien and
limitation of domain.

If pre-emption rights apply, warranties should also confirm that either:

• the shares have been issued or transferred (as applicable) in accordance with the pre-emptive rights procedures in
the buyer's constitution or relevant shareholders' agreement; or

• those pre-emptive rights have been waived.

The shares should also be free from any encumbrances or other security interest and not restricted by liens and
limitations of domain.

• Description of rights attached to shares. This should provide a description of the relevant economic and/or corporate
rights attached to the shares being issued.

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Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

• Compliance with local laws. That the shares are duly issued pursuant to local law and in accordance with the buyer's
bye-laws.

• Incorporation. That the buyer is duly formed and validly exists under the laws of its place of incorporation.

• Authority/execution. That the buyer has the requisite corporate power and authority to enter into the agreement and
perform its obligations under it (including to issue shares to the seller) and that the execution of the agreement and the
consummation of its related transactions have been duly authorised by all necessary corporate action.

• Absence of third-party approvals. That no approval, authorisation, waiver, registration or notification (by a
third party or a governmental body) is required to be obtained in connection with the execution, performance or
enforceability of the agreement by buyer.

• Insolvency. That the buyer is not insolvent and has not entered into, taken any steps or is otherwise likely to enter into
any insolvency (or related) event.

• Freely transferable. If the buyer is an entity listed on a stock exchange, then the shares are listed on that stock
exchange and are freely transferrable.

• No conflicts. The buyer should also represent and warrant to the seller that the issue of the shares would not:

• result in a material breach of any agreement to which the buyer is a party;

• violate or conflict with any applicable law; or

• result in any liability, suit or action from any third party against the seller or the buyer.

Statutory Restrictions on Transfer of Shares

Generally, there are no relevant statutory provisions that would limit the capacity or authority of an entity to issue options, or
any similar restriction for the holder of the options to exercise any options received.

However, it is common to find these restrictions in the bye-laws of the issuing entity. The restrictions are agreed between the
shareholders or partners of any given entity and would require a previous waiver by those shareholders or partners if they are
to be disapplied.

Transfers to Third Parties

As an option is deemed to be a binding offer, which the owner may effect at will, it is important to consider the transferability
of the option (see What Are Put or Call Options?) and either:

• Include a provision in the option agreement limiting the transferability.

• Provide that the option may be freely transferred.

Option holders usually have the right to transfer the options they hold to third parties. This right is not typically specified as being
a personal right nor provided for in put or call agreements. Rather, the relevant right is commonly found in the incorporation
deed and/or shareholders' agreement of the company (if any). The incorporation deed and shareholders' agreement (if any)
might provide certain terms and conditions on the transfer of shares and consequently limit on their transferability, such as

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Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

those relating to pre-emptive rights. Before any transaction, such documents must be reviewed to avoid the potential for any
nullity of the transfer of shares.

Employee Consultation
There is no statutory requirement to consult with employees where the exercise of an option results in a transfer of control
over the company. Although, the company may choose to incorporate such a requirement in its constitution or shareholders'
agreement.

For more information on employment law issues to consider when acquiring a private company or a business in Mexico, see
Practice Note, Employees: Cross-Border Private Acquisitions (Mexico).

Dividends
There is no mandatory provision in Mexico restricting the freedom of the parties to decide on the treatment of dividends and
any other distributions related to shares subject to an option. However, standard practice is that, if the shares are validly issued,
no distribution would be made that might affect their price before the option is exercised (or not exercised, as the case may
be). Although not mandatory under Mexican law, option agreements generally provide that the issuing entity will not distribute
dividends or any other contributions on shares subject to an option. The shareholders or the board of directors of the issuing
entity would be a party to the agreement to undertake such a commitment.

Should the consideration be exchanged at the time the put or call option is exercised, the price would vary greatly depending
on the economic attributes that the shares in question retain at that moment. This would, however, be a matter of negotiation
between the relevant parties. In other words, the consideration payable by a party receiving shares would generally not be the
same if the shares have no accrued dividends which may be collected by the recipient at a later point.

Warranties in an Option
In addition to the warranties set out in Standard Document, Put and Call Option agreement: Cross-border, the general warranties
provided by the seller, as transferor of the option shares, are:

• That the option shares are validly issued and free and clear from any and all liens and limitations of domain.

• That, in case of a put option, there are no third-party agreements, options, warrants or any similar undertakings that
would restrict or limit the seller's capacity to freely issue and transfer the shares to the buyer free and clear from any
and all liens and limitations of domain, or, in the case of a call option, restrict the authority of the seller to acquire and
receive the shares freely and without any lien and limitation of domain.

• That the issuing of the shares will not create a breach under any agreement to which the seller is a party, or result in a
liability, suit or action from any third party against the seller or the buyer.

• That the issuer is not, will not be, nor has ever been subject to bankruptcy, dissolution, or any similar or analogous
proceedings.

• That the issuer is able to pay its debts as they become due.

• That the issuer is not threatened with, or subject to, proceedings that might affect the shares (in-rem) or the issuing of
the shares.

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Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

• That the issue or transfer of the option shares to the buyer is not subject to third-party authorisations or consents. If any
third-party authorisations or consents were required, the issuer would obtain them before the closing date.

• That the issuing of the option shares complies with all applicable laws for whichever period is longer between the
past five years or the applicable statute of limitations (including tax laws). The seller should also state that it has
submitted any and all required tax returns, forms or similar documents for the past five years, as five years is the
general limitation period for tax matters (extendable under certain circumstances).

• That the seller will conduct the business in its ordinary course during the option period.

• That, as of the closing date, the issuer will have sufficient financial resources to continue its operations as it has done
for the past years.

The representations and warranties of each party are usually subject to lengthy negotiations. In particular, when a party acquires
shares, it must be confident that it is not also acquiring any unexpected liabilities attached to or arising from them.

Anti-Dilution Mechanisms
It is common to provide in a put and call option agreement that, in the event that an option is exercised, the bye-laws of the
issuer will be amended to include certain provisions protecting the original shareholders. These protections may include:

• That the option shares may never represent more than a given percentage of the outstanding shares of the issuing entity
(such as 40%).

• That all shareholders must agree on the issue, sale or transfer of new shares. This creates certainty that the current
shareholders are not retaining a right of first refusal or similar right which could potentially trigger a dispute with the
recipient of the shares.

• That all newly-issued shares are assigned restricted voting rights, or that unanimous consent (or a lower threshold) is
required to adopt any resolutions.

• Any other contractually negotiated rules, options, and limitations.

Formalities to Transfer the Shares on Exercise

Only a few formalities from a corporate perspective are required for a corporation (sociedad anónima) to issue or transfer
shares. These mainly involve:

• Endorsement of the shares certificates (if the actual physical certificates have already been issued before the option is
exercised). If no certificates have been issued, then such particularity must be included in the agreement.

• Recording the new holder in the shareholders' registry ledger of the issuer.

Under Mexican law, only stock corporations (sociedades anónimas) can issue shares considered to be freely exchangeable.
Other entities, such as partnerships, issue equity quotas or interests, which are not freely transferable without prior consent from
all the partners holding equity in the issuing entity.

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Put and Call Option Agreement (Mexico): Checklist, Practical Law Checklist w-034-3424

Although there are no technical restrictions on a partnership to enter into call or put agreements, this happens rarely as
partnerships are smaller, more limited and more heavily regulated, and their legal framework would lead to a more burdensome
process as certain rights would have to be waived.

END OF DOCUMENT

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