This article is written by Ian Hargreaves (partner) and Robert Bolgar-Smith (associate).
Companies that operate in numerous jurisdictions have long faced the burden of complying with various regulatory regimes that can vary significantly and change rapidly. Increasingly, however, regulators are expanding not just the extent of the regulations but also their jurisdictional coverage.
Regulations such as the UK Bribery Act 2010 (“UKBA”) and US law by the Foreign Corrupt Practices Act 1977 (“FCPA”) have wide extra-territorial application and foreign companies with UK or US elements can find themselves facing vast penalties and potential criminal sanctions against itself, its employees and its directors.
The expansion of the regulatory regime has resulted in a much more visible compliance culture across the board. One area where we are seeing significantly increased levels of interest in anti-bribery and compliance requirements is at the due diligence stage of transactional work (“ABC Due Diligence”).
Irrespective of whether companies are investors looking to expand their portfolios or are looking for acquisition-led growth, they are appreciating the necessity of confirming that a target company is compliant with all applicable regulatory regimes.
Many companies and investors in the West have the perception that conducting business in Africa is rife with corruption, particularly when dealing with government officials, and indeed this has some truth in some countries. There are also plenty of high profile examples of multinational companies receiving severe fines in relation to their activities in African countries to support this perception; from Alcatel Lucent in relation to telecoms contracts in Kenya, Nigeria, Angola, Ivory Coast, Uganda and Mali to BAE Systems for false statements and accounting practices in Tanzania.
However, it is important to acknowledge that Africa is not, and cannot be considered as, a homogeneous entity. There are many African countries which have developed, and are increasingly vigorously enforcing, domestic anti-bribery and corruption legislation. Whilst the risk of compliance issues means that companies conducting business in Africa need to be cautious and conduct the necessary due diligence, this is no reason to not invest.
Due Diligence Processes
A purchaser cannot assume that a target company will already be compliant with either its current regulatory regime or with any additional regulatory requirements that it may become bound by once it joins the acquiring company’s group. The level and thoroughness of the due diligence that a purchaser undertakes in relation to subsidiaries / third parties is a factor that regulators will consider when they are deciding whether to prosecute alleged violations of compliance regimes. In certain circumstances, a purchaser can be found liable for the acts of its predecessor in title.
As with all due diligence processes, it is important that the parties start by determining the key compliance risks for that specific transaction. The focus of an ABC Due Diligence exercise will therefore change depending on the industry, jurisdiction and history of the target company.
It is also a dynamic process and, as it progresses and further information is uncovered, the focus may change. For these reasons, it is preferable for parties to use a cascade mechanism whereby each identified issue is put through increasingly rigorous due diligence processes (from questionnaires sent to the target up to gathering human intelligence through covert investigations).
In order to be effective, it is vital that the information gathered during the ABC Due Diligence is clearly communicated to the board of the purchaser so that key acquisition indicators are identified and can be acted upon. Key reporting lines must be established and maintained and it is common for a non-executive board member to be appointed to oversee the ABC Due Diligence process and to act as a conduit between the acquisition team and the board.
There are numerous areas which may need to be considered when beginning an ABC Due Diligence process, including political risks, dealing with state owned enterprises, corporate social responsibility, manipulation of accounts and concerns in relation to employees.
Government Licences and Fees
One area which is a specific risk and regularly causes concerns during and following acquisitions in many jurisdictions is government licences and fees. Target companies often require licences from or have to pay fees to local or national governmental bodies (for example oil and gas licences, transport licences, export / import licences and planning permissions). This is a high risk area for companies (particularly in certain jurisdictions and industries (i.e. the oil and gas sector) since the importance of these licences and the lack of transparency has traditionally resulted in significant corruption risks.
In addition to any local law requirements, the types of payments that can be made to foreign public officials are highly restricted under English law by the UKBA and FCPA which, as mentioned above, both have wide extra-territorial applicability. As such, where either the purchaser, one of its subsidiaries or the target company conducts business in the UK or US then compliance breaches in a third party jurisdiction can be enforced under these regulations.
The principle of corporate liability created in section 7 of the UKBA means that companies will be liable for their employees’ actions in relation to bribery where the company does not have adequate procedures in place. Other key risks include payment of bribes (s.1 UKBA), receipt of bribes (s.2 UKBA), facilitation payments (Ss1 and 6 UKBA), Books and Records offences under US laws and facilitating transfer of proceeds of crime in breach of UK Proceeds of Crime Act.
Breaches of these laws can lead to severe penalties including unlimited fines, custodial sentences for directors and senior management, debarment from tendering for public contracts, the inability to work with or receive investment from international organisations and the imposition of a monitor.
By way of example, Mabey & Johnson, a British engineering company, self-reported to the UK Serious Fraud Office in 2008. It admitted to systematically paying bribes in numerous jurisdictions and was ordered to pay £131,201 under the Proceeds of Crime Act along with the successful prosecution of two former company officers.
Prosecutions of this nature also risk becoming highly publicised with the consequent risks to the reputation of the company and its management as well as invalidating licences and contracts upon which the company relies.
Purchasers also need to be careful to investigate the role of intermediaries/agents used by the target company. Companies which are knowingly committing compliance offences often use agents/intermediaries to attempt to distance themselves from the relevant actions and, even where the target company is itself compliant/has the necessary procedures in place, this is an area where it will have the least control and may be unknowingly committing offences.
The actions of the target’s agents need to be an active consideration for the purchaser since the target, and going-forward the purchaser, may potentially be liable for their actions.
Flushing Out Concerns
A multi-tiered, cascade approach to ABC Due Diligence will regularly be the most reasonable in terms of cost whilst also providing sufficient protection to the purchaser. Any concerns arising from the initial due diligence checks should indicate whether the various levels of more extensive due diligence are necessary or indeed bespoke checks.
In all situations, consideration must be had as to what would be deemed “adequate” by applicable regulators, the cost to the purchaser and what is practical. It is, for example, unlikely that the target company will provide significant (if any) access to its employees/relevant third parties at an early stage in the acquisition process.
There are a number of broad, preliminary measures that can be undertaken for each risk identified including:
- sending questionnaires to the target and related follow-up;
- reviewing relevant agreements and licences made by the target; and
- conducting general online research including publically available data.
Specific issues, for example the use of intermediaries/agents, will require the purchaser and its advisers to take issue-specific steps (i.e. review the agency agreements, understand the basis upon which agents are engaged and determine potential attributable risks). In some circumstances, it may be advisable to escalate straight to the more advanced due diligence processes for certain issues at a preliminary stage.
Where the results of the preliminary ABC Due Diligence raise concerns or are inconclusive, further steps can be taken including interviewing the target's senior management, extensive reviews of relevant agreements, extensive public record searches, screening of agents, intermediaries and third parties and the use of forensic accountants to identify red flag transactions.
Ongoing concerns can then be escalated to include interviewing employees beyond the target’s senior management, sending questionnaires and/or interviewing senior management at third parties, conducting comprehensive search and analysis of online and print media in multiple languages, obtaining a financial / forensic analysis of specific risk associated with specific agents, intermediaries and/or third parties, and undertaking investigative due diligence.
Where issues are identified through the ABC Due Diligence process, the purchaser has the opportunity to take remedial steps, for example, requiring the target to formalise / amend relevant agreements, obtain legal advice and contractual protections (i.e. indemnities or escrow/ deferred payments), and / or require the target to implement new procedures.
Where remedial steps are either not available or insufficient, the purchaser can use these concerns to reduce the acquisition price or, as a last resort, to pull out of the transaction entirely.
It is clear that ABC Due Diligence is now a critically important element of transaction due diligence and the approach, practical steps and considerations set out herein are highly recommended to those investing in Africa.