Completing a private equity investment in an African target company generally raises more anti-corruption risks than in other parts of the world. Many African countries are considered by international surveys to be among the most corrupt in the world, and a target’s compliance practices may be limited (or non-existent) compared to companies operating in other areas of the world. The risks for an investor that can result from corrupt activities of a target may be significant – from losing value on the investment to being held liable for previously unknown wrongful acts committed by the target, its local shareholders or others acting on their behalf.
International business transactions are subject to intense scrutiny due to the broad scope of the U.S. Foreign Corrupt Practices Act (FCPA) and the UK Bribery Act, in addition to other similar anti-corruption measures around the world. Given the significant penalties that can result from violations of these laws, private equity investors can no longer afford to overlook the risks deriving from potential compliance violations attributable to a target or its shareholders before completing a deal. As a result, investors must:
- thoroughly assess compliance risks through due diligence,
- protect their investment by drafting contractual “shields” in the investment agreements, and
- include post-close protections in the shareholders agreements.
1. Due diligence and compliance
When a private equity investor considers the feasibility and opportunity of a private equity deal in Africa, it is important to first conduct thorough due diligence to assess the anti-corruption compliance risks regarding both the target and its shareholders as soon as possible. The main objectives of such due diligence should be to:
- clearly identify and assess the risk exposure of the target and, indirectly, of the potential investor,
- calculate the financial impact of the due diligence findings on the final transaction and assess whether such findings may deter the investor from completing the transaction, and
- determine the structuring of the investment and the implementation of contractual measures that need implementation in order to reduce such risks.
In practice, such due diligence should involve assessing the:
- main shareholders and key managers,
- major client and supplier contracts,
- contracts involving public authorities or state-owned enterprises, and
- other activities involving public authorities, such as obtaining permits and regulatory licenses.
Indeed, there is a high risk for the target (and potentially, the investor) to be exposed to prosecution by multiple authorities in different jurisdictions for the violation of anti-corruption laws, especially under the theory of successor liability in which an investor may assume liability for a target’s pre-existing violations of anti-corruption laws. In practice, this means that in addition to potential liability for corrupt activities conducted by the target post-close, a private equity investor taking control of an African target also could be held liable for corrupt activities engaged in by the target prior to the time of investment if such activities were in violation of the FCPA or other anti-corruption laws at the time they occurred.
It is important to note that the FCPA applies not only to entities incorporated or listed in the U.S. (and their subsidiaries), but also to any other entity that acts, or causes others to act, in furtherance of prohibited bribery while in U.S. territory or by using U.S. interstate commerce. The U.S. Government interprets broadly the interstate commerce requirement in order to assert FCPA jurisdiction over activities conducted by non-U.S. persons outside of U.S. territory that have only limited connections to the United States, such as making phone calls or sending emails from the United States in furtherance of a bribery scheme otherwise occurring entirely outside of the United States.
An investor also might be held liable even if:
- the activities were not subject to the FCPA at the time, but they continued subsequent to an investment that caused the FCPA to apply, or
- the corrupt activities ceased prior to investment, but resulted in future or ongoing returns on the investment for the investor post-close.
In principle, successor liability should not create liability under the FCPA – meaning that if an investor subject to the FCPA acquired a target that was not previously subject to the FCPA, then the mere acquisition does not retroactively create FCPA liability for the investor. However, post-completion of its investment, the investor must take steps to halt any ongoing corruption and implement a compliance program to prevent future potential improper activities.
An investor that fails to investigate or remediate the conduct of a target (including by failing to take steps to implement a compliance program at a target) can be subject to prosecution resulting from the prohibited conduct engaged in by the target. Such liability depends primarily on two related factors:
- the extent to which the investor has control over the operations of the target company or companies engaged in prohibited conduct, and
- the level of knowledge the investor has regarding corrupt activities engaged in by the target before and/or after investment.
Other risks associated with a non-compliant target may include:
- reputational consequences,
- erosion of shareholder value due to public enforcement proceedings,
- shareholder derivative litigation, and
- financial losses relating to a decrease of the target’s value, such as by losing contracts that had been obtained through corrupt means.
The investor must also comply with the compliance standards required by its own investors and fund providers to avoid any potential liability towards them.
2. Contractual safeguards applicable to the pre-closing period of the private equity investment
It can be difficult for an investor to detect potential wrongdoings by the entities or people involved in the target’s business. Furthermore, the timing of such acts can be situated in the past but can also be ongoing. Regardless of the level of due diligence that can be conducted, when drafting contractual safeguards in an investment agreement, the investor needs to take into account the possibility of corrupt acts in order to reduce exposure to such risks.
To do so, the investor has a resourceful set of tools to shield himself against both identified and non-identified risks:
First, representations and warranties offer two distinctive functions:
- an informative function through disclosure of information, and
- a compensative function through the activation of warranties if the information or warranties provided proves to be wrong.
The scope of the representations and warranties should be wide to protect the investor against any wrongdoing committed by or on behalf of the target or its existing shareholders prior to, or in furtherance of, the transaction (such as bribes paid to obtain ongoing contracts with government customers or regulatory approvals necessary for the completion of the investment). To the extent specific risks are identified in due diligence, representations and warranties also can be drafted to more precisely cover such issues.
Secondly, the investor can protect himself from identified risks by implementing specific indemnification mechanisms. These indemnities would be activated in case such risks materialize into losses following completion of the investment.
Thirdly, material adverse changes and conditions precedent clauses in relation to compliance can enable the investor to walk away from the contemplated investment if corrupt activities are identified before the investment has been completed, while covenants can provide protection with respect to the conduct of business of the target during the interim period between signing and closing.
3. Contractual safeguards applicable to the post-closing period of the private equity investment
The investor also needs to be sure that it possesses sufficient contractual rights in the shareholders agreement to mitigate post-close compliance risks. These tools should enable the investor to have a clear overview of the management, key personnel and compliance program – if corrupt activities occur or are suspected, the investor should have the ability to pull out from his investment or to carve out the affected portion of the business. This could be accomplished by negotiating a call or a put option to be triggered by certain events which may include, but need not be limited to, post-investment discovery of bribery or other prohibited conduct (or credible allegations of same) by (a) the target, or (b) such entity’s shareholders and / or managers.
(i) The management and compliance program
Specific contractual protections of the shareholders agreement should enable the investor to adequately supervise the management of the target from a compliance standpoint. The investor also needs to have its say in the appointment of key managers and compliance/legal personnel at the target level. In practice, the shareholders agreement must determine the competent body for the appointment and control of such personnel and clearly list their mission and powers. In addition, the investor needs to be able to easily trigger compliance audits of the target, either on a routine periodic basis or in response to the discovery of potentially-improper behavior. Furthermore, the shareholders agreement should require the target to implement (or enhance) a compliance program in a form satisfactory to the investor. These steps will provide the investor with a stronger ability to identify and correct potential compliance issues.
(ii) Put option
A put option would enable the investor to exit the deal upon the discovery of corrupt activities post closing. Applicable anti-bribery regulations typically would not prohibit the investor from receiving fair market value for its ownership interest in the target. This is the case even where the payment of the sale price is made by one or more persons or entities (including shareholders or managers) that engaged in improper activities.
Concerns could arise in the context of determining “fair market value” for the investor’s stake because the entity’s value might be based, at least in part, on proceeds arising from corrupt activities. This would need to be addressed on a case-by-case basis involving fact-specific analysis. In theory, it should be possible to carve out any proceeds arising from corrupt activities so that a valuation is calculated based only on the activities of the target that are not under suspicion.
(iii) Call option
With the call option, the investor would seek to buy out from the target a non-compliant shareholder. There may be a concern that exercising a call would result in the investor paying money to a shareholder which has acted in a manner that violates applicable laws, and that these funds may be used by the recipients to further their corrupt activities. To address this concern, the call may be structured to require the recipient to certify in advance that the proceeds to be received would not be used to conduct additional prohibited acts. While such contractual rights may not be enforceable, they may reduce the investor’s potential liability by demonstrating the investor’s seriousness of purpose and commitment to compliance both to the target’s shareholders and to any enforcement authorities who might review the matter thereafter.
Negotiating put and call options would only be efficient as long as the investor makes sure that the enforceability of these contractual provisions is available in the target’s jurisdiction. If not, the investor should consider investing in a holding company above the target which could be incorporated in a friendlier jurisdiction for the enforceability of put and call options.
In addition to put and call provisions, the investor can also negotiate the blocking of voting rights and payment of dividends into an escrow account as alternatives or interim measures pending the exit of the non-compliant party.
(iv) Information rights regarding other shareholders
Finally, the investor must be able to know the identity of other reference shareholders of the target are in order to ensure that it is not dealing indirectly with non-compliant or otherwise problematic parties. For that purpose, the shareholders agreement should contain provisions enabling the investor to be informed of any change in the shareholding structure of its co-investors. This would enable the investor to trigger the put or call options described above if necessary.
Ultimately, the steps taken to mitigate compliance risks should be tailored to address the specific risks raised by the target at issue. Conducting comprehensive due diligence prior to an investment – particularly for targets operating in high-risk jurisdictions and business sectors – will help inform the necessary contractual protections in investment and shareholder agreements.