Insight

Caveat Sanctions and Export Controls

Increasingly strict global sanctions and export-control regulations add a new layer of potential peril to M&A deals. A guide to expanding due diligence to ensure that malfeasance, whether intentional or accidental, doesn’t end up scuttling the agreement.

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CB

Carsten Bormann and Stephan Müller

September 29, 2022 04:30 PM

Comprehensive sanctions packages and constantly changing export-control requirements to enforce national and international foreign and security policy objectives demand from companies a new, sturdier edifice of compliance efforts. At the same time, investors in mergers-and-acquisitions transactions need to broaden their due diligence to include a check of the target company’s foreign-trade compliance and ensure that any risks are appropriately distributed and reflected in the purchase agreement.

Risk Factor Sanctions and Export Control

The sanctions imposed on Russia by the European Union and Western allies are some of the most comprehensive ever levied on a single state. All the same, global geopolitical tensions had been increasing even before Vladimir Putin’s invasion of Ukraine. In this environment, sanctions, the control of exports of critical technologies and screening of foreign investments have become key tools for governments to enforce their security interests. In this context, compliance with legal requirements poses considerable challenges for companies and has become a central component of risk assessment for M&A investors.

European companies must comply with legal requirements at various levels: export controls and sanctions at the European and national levels; American regulations with extraterritorial impact; and political efforts, both Europe-wide and national, that could prohibit adherence to certain sanctions.

The regulations are manifold: sanctions and embargoes against certain states and individuals, export and import restrictions, and licensing requirements for certain products and services, among others. Acts that violate these restrictions are null and void under civil law and, if committed negligently or intentionally, generally constitute an administrative or even a criminal offense. The risks for investors are considerable, as they face severe fines and serious economic consequences if, for example, they are denied access to markets in whole or in part. Due diligence is therefore critical.

Generally speaking, risks exist for an investor if, at the time of the acquisition, there has already been a sufficiently concrete breach of duty by the target company. In a share deal scenario, this means that while the target company remains liable for its past legal violations, the acquirer obtains the shares “infected” with the liability risk. Possible liability risks of the target company that may transfer to the acquirer in a share deal include liability for fines, claims for damages and liability from breaches of contract—e.g., for terminating contracts in violation of the EU Blocking Regulation or the regulatory regime prohibiting EU businesses from complying with certain extraterritorial US sanctions targeting Iran and Cuba. At the same time, continuation of the target company’s business without adequate trade compliance also poses a significant risk.

For example, while German authorities are, within their jurisdiction, generally obliged to investigate and prosecute any violation of applicable sanctions and export-control restrictions, the number of cases in which noncompliance has triggered investigations and the imposition of fines or criminal penalties has, until recently, been rather limited. However, in light of the poor enforcement of EU sanctions by national authorities and the European Commission’s pressure on member states to ensure effective prosecution of sanctions violations, the German Parliament recently enacted a first package of the Sanctions Enforcement Act (Sanktionsdurchsetzungsgesetz), which contains, inter alia, new investigative measures for competent authorities. The federal government expects that all these measures will, in the near future, increase the number of official investigations and prosecution of sanctions violations.

Consequences for M&A Transactions

Considering the complexity and dynamics of legal requirements, the question is therefore not merely whether companies have committed any violations at all. Instead, investors must determine whether potential breaches are substantial and whether target companies have implemented sufficiently capable compliance mechanisms to prevent such infringements going forward.

If compliance violations come to light during due diligence, the acquirer is regularly legally obligated (often under the company’s own internal compliance regime) to ensure that the violations are remedied before assuming responsibility for the target company’s business operations. For instance, the acquirer could obligate the target to stop exporting certain products or to terminate business relationships with certain customers. If compliance systems are inadequate, improvements must be made in the near term.

Risks exist for an investor if, at the time of the acquisition, there has already been a sufficiently concrete breach of duty by the target company."

In addition, provisions can be included in the purchase agreement to appropriately distribute risk. A purchase-price adjustment clause allows the acquirer to change the price at closing to reflect both liabilities from compliance violations and investments in compliance improvement.

If the purchase agreement contains a compliance guarantee, violations can be agreed to be a condition precedent and the buyer granted the right to refuse to conclude the transaction should a violation occur. This measure can be highly effective at ensuring the target’s compliance by the time the deal concludes.

Through a comprehensive guarantee, compliance with international trade regulations can also be secured. However, sellers will routinely attempt to limit the guarantee “to the best of their knowledge and belief” in order to limit damage claims.

Finally, the parties can agree that the seller will indemnify the buyer against certain compliance violations. This is especially relevant in matters that have a significant impact on a company’s value and for which a final assessment is not possible at the time the purchase agreement is completed.

Conclusion

In light of the rapidly evolving legal framework for foreign trade, investors need to broaden the scope of their due diligence to analyze a target’s compliance measures comprehensively. M&A buyers must also ensure that potential risks are adequately identified and reflected in the purchase agreement.

Stephan Müller is a lawyer at Oppenhoff and specializes in export control law, sanctions and compliance with a focus on the areas of anti-corruption, money laundering and internal investigations. His advice is particularly sought after in crisis situations. He has special experience in developing and implementing compliance structures. He also advises his clients in permission proceedings or before the administrative courts.

Dr. Carsten Bormann is a lawyer at Oppenhoff and advises and represents national and international clients on all questions concerning public/regulatory law and foreign trade. His work includes, in particular, advice to international companies in the context of foreign direct investment screenings. Further areas of his expertise are export control and sanctions law, with an additional focus on the development and implementation of compliance structures.

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