Global risks, local remedies: Cross-border M&A issues in the New Europe
The authors report from the IBA European Regional Forum conference in Warsaw on a discussion among lawyers from throughout Central & Eastern Europe on the best ways to minimise common risks encountered in international transactional practice.
The expanded membership of the EU and the growing number of cross-border transactions in Europe have naturally led to the standardisation of M&A procedures within the member states through use of similar documentation and action lists across various EU jurisdictions. But every international project includes elements of local law that require special attention. Cultural differences can also have a bearing on the transaction.
An opportunity to exchange views on this subject was provided during the International Bar Association European Regional Forum conference in Warsaw in November 2012. Lawyers attending the conference from almost 30 different countries in CEE and elsewhere in Europe debated the opportunities and challenges for growing businesses in the new EU member states. A more detailed analysis of the issue of risks in multinational projects took place at a workshop entitled “Assessment of Risk in Cross-Border M&A Transactions.” The discussion was led by a panel of lawyers practising in Bulgaria, Hungary, Poland, Russia and Sweden.
Knowing how to identify and deal with the risks that may arise in a given jurisdiction is vital to achieving the desired effect of an international transaction. Success depends on skilful and efficient handling of all features of the project.
There are certain risks that are common across jurisdictions, but the same risk may bear different consequences and be treated differently depending on where it arises. Indeed, as became apparent at the workshop, different approaches to a specific risk may be found even within a single country, as transactions vary and local practice does not always provide a common approach to legal problems.
For example, some of the typical risks in almost any jurisdiction concern proper title to shares (for share deals), the effect that debt of the target company may have on the transaction, proper title to real estate and the effect of disclosure in the land register, and labour law issues such as the risks connected with the use of traditional employment contracts versus alternative forms of employment. Another interesting aspect is the approach to certain information about the target company gleaned from due diligence that may pose a risk for the transaction, in the form of “sandbagging” provisions existing in various jurisdictions.
Title to shares
An assessment of whether the sellers of a limited-liability company (or equivalent in the specific European jurisdiction) hold proper title to their shares may often necessitate looking at the effect of entry of the shareholders in the commercial register or equivalent and the required form of transfer documents in the given jurisdiction.
This is especially important in some European countries, such as the Czech Republic, Germany, the Netherlands and Poland, where transfer of shares requires a more rigorous form, with notarised signatures or the form of a notarial deed. In other countries, such as Belarus, Lithuania, Romania and Switzerland, ordinary written form is sufficient to convey title to shares.
Most of the European practitioners at the workshop stressed the need to examine the source documentation behind past share transfers. This is a necessity in countries, such as Poland, where the commercial register does not provide a warranty of public reliance on the register. But also in other jurisdictions, for example Russia, where entry of the holders of title to shares is deemed to provide security to third parties, potential buyers are nonetheless encouraged to review past transactions closely.
A panellist from Budapest explained at the IBA workshop that although in the case of a Hungarian limited-liability company (Kft) shares are transferred upon entry in the commercial register, the entry is made by the court on the basis of the list of shareholders provided by the managing director of the company, who, in turn, acquires information on the transfer directly from the new shareholder. Presentation of the document which was the basis for the transfer of shares is not mandatory. In consequence, it is not possible to rule out a risk of false or inaccurate information being entered in the company register without the court being able to verify it—hence checking the source documents for prior share transfers in the course of due diligence might be advisable.
Too much debt
It is commonly indicated that excessive debt of the target company, a situation disadvantageous for the entity itself, may also pose some risk for the buyer. Therefore certain measures should be undertaken before the transaction in order to improve the financial standing of the company, or the transaction should be structured to deal with this risk optimally.
If the target company is insolvent, the law usually requires the management board of the company to file for commencement of insolvency proceedings within a certain period. For example, in Poland there is a time limit of 2 weeks, or 30 days in Bulgaria, as pointed out by a panellist from Sofia. Creditors may also file bankruptcy petitions.
The panellist from Bulgaria went on to explain that if the target is in poor financial condition, its position may be made more secure before carrying out the sale of shares, for example by increasing the share capital through a capital increase or conversion of debt to equity, or restructuring the existing debt.
An asset deal may also be considered—provided that the assets have not been pledged as collateral, or the consent of the secured creditors is obtained. The risk of anyone challenging the transfer of assets by a distressed company may be mitigated to some extent by obtaining an independent valuation of the assets to ensure that they are being sold at fair market value.
Participants representing most of the CEE countries present at the workshop shared a common perspective in this matter.
Due diligence is designed to provide the potential buyer an opportunity to identify certain risks related to the target. Once the risks have been identified, the parties can make an informed decision on whether to proceed with the transaction, and if so, how to address any risks that are identified in due diligence.
As the participants at the workshop pointed out, some risks identified in due diligence cannot be eliminated prior to the transaction, but the parties may nonetheless decide to proceed with the deal anyway, making relevant provisions to cover the risks in the transaction documents.
This raises the issue of “sandbagging.” Depending on the applicable regulations in the specific jurisdiction, the buyer’s knowledge of risks acquired prior to signing the agreement may be an obstacle to effective assertion of a claim under the contractual representations and warranties. With “pro-sandbagging” provisions, the buyer may be given the right to seek indemnity regardless of its knowledge of the risk, while “anti-sandbagging” provisions make the buyer’s right to seek indemnity dependent on the state of the buyer’s knowledge.
For example, in Sweden, according to an M&A practitioner from Stockholm, under statutory law a buyer may not assert an effective claim for an inaccuracy which the buyer had knowledge of at the time of signing. Under the principle of freedom of contract, however, the parties often include provisions in the transaction documents determining what effect the buyer’s knowledge will have on the parties’ rights. More often than not, anti-sandbagging provisions are used.
According to studies cited at the conference, in European jurisdictions anti-sandbagging provisions are perceived as more common (51% anti-sandbagging v 7% pro-sandbagging), while in the United States, pro-sandbagging provisions are more common, meaning that the representations and warranties are absolute and unaffected by the buyer’s knowledge (41% pro-sandbagging v 5% anti-sandbagging).
The participants at the workshop were evenly split on whether their home jurisdictions governed this issue by statute. There was also a split, although a positive answer seemed to be more common, on whether it was customary across different jurisdictions to include provisions in the transaction documents limiting the seller’s liability based on knowledge obtained by the buyer during due diligence.
In the case of Poland, the statutory provisions generally exclude the seller’s liability under the warranty for defects if the buyer was aware of the defect at the time of the sale. However, it is generally possible to extend, limit or exclude liability under the warranty for defects, and therefore the parties will usually address this issue in the share sale agreement.
As was clear from the discussion at the IBA conference, ultimately the success of any international transaction, large or small, will depend on proper identification of current and potential risks at the local level and the ability to deal with the risks appropriately. An issue regarded as immaterial in one jurisdiction may turn out to be a deal breaker just across the border.
Anna Dąbrowska, Izabela Zielińska-Barłożek, Mergers & Acquisitions Practice, Wardyński & Partners