Overseas Financing and Acquisitions: The Increasing Importance of Anti-Corruption Due Diligence

Introduction

The Corruption of Foreign Public Officials Act (CFPOA) provides Canadian federal authorities with the power to levy both criminal charges and unlimited monetary penalties against individuals and entities found to have engaged in the bribery or other corruption of foreign officials in their overseas business dealings. Prosecution can also lead to the forfeiture of the proceeds of bribery and, in some cases, to the debarment from dealings with governments and organizations such as the World Bank and the United Nations.

Beyond these potentially severe consequences, the reputational impact of failing to abide by the CFPOA can lead to substantial deterioration of shareholder value. Perhaps most importantly, corrupt practices can also lead to shareholder derivative claims, class actions or the undermining of the rights and benefits to which a company is entitled in a foreign jurisdiction.

The Canadian government has recently demonstrated an invigorated commitment to the enforcement of the foreign anti-corruption provisions of the CFPOA with reportedly over 20 investigations currently underway. For a detailed discussion of the CFPOA, its prohibitions and potential penalties, as well as recent enforcement action, see A Deeper Dive Into Canada’s First Significant Foreign Bribery Case: Niko Resources Ltd.

This apparent change of course in the policy of federal authorities marks a new period in foreign investment transactions and necessitates a re-evaluation of the legal due diligence strategies employed by financiers and prospective acquirers alike, as well as for issuers and other companies operating in foreign jurisdictions in general. This includes: (i) general due diligence review of the prospective issuer or target’s operations and assets; (ii) specific due diligence inquiries into the prospective issuer or target’s policies and procedures, corporate records, contractual arrangements and business partners; and (iii) due diligence inquiries into the potential effects of corrupt practices on the prospective issuer or target’s foreign assets, operations and rights.

General Anti-Corruption Due Diligence Considerations

On a general level, when conducting due diligence for anti-corruption issues, focus on those characteristics of a transaction or issuer which, in the aggregate, may heighten concerns in respect of corrupt practices. Some of the more significant warning factors can include:

  • The ranking of the host state on the Corruption Perception Index published by Transparency International. This index ranks countries annually by their perceived levels of corruption in respect of business dealings, as determined by various assessments and opinion surveys.
  • The prospective issuer or target company’s involvement in the resources extraction sector of a developing country, including mining and oil and gas. Generally speaking, the resources sector of developing countries is perceived as particularly fraught with corrupt practices, and is a main concern of anti-corruption authorities and policies.
  • Agency or consultancy agreements executed by the prospective issuer or target in which payment is conditional upon the agent successfully obtaining a government contract for the company, including a license, concession or production sharing contract. Contingent payment arrangements generally constitute a "red flag" for anti-corruption authorities. Unusually high commissions should also be spotlighted.
  • The retention by the prospective issuer or target of agents or consultants with direct or indirect ties to local public officials. Regulators will likely seize on agency arrangements within arm’s-length of the host government regardless of their other characteristics. Suspicion may also be raised where agents with less than appropriate resources, expertise or qualifications are engaged.
  • Unusual payment patterns or financial arrangements, dealings in cash, or lack of documentation or transparency by the prospective issuer or target in its expense and accounting records. These may exhibit, or be designed to mask, evidence of wrongdoing.
  • Lack of any anti-corruption compliance processes and procedures. Although the CFPOA has been in force since 1999, there are still many Canadian firms that have failed to put together even a rudimentary written policy on anti-corruption compliance.
  • Resistance from the target’s executives, directors, employees, agents or business partners to responding to anti-corruption questions regarding their operations.

Drilling Down: Specific Anti-Corruption Due Diligence Procedures

Once there is a clear understanding of the general risk factors at play for the prospective issuer or target, develop a plan for conducting specific due diligence inquiries into their activities, practices and policies. This should be done with a view to providing sufficient time for prudent further inquiries into potentially concerning circumstances and mitigating the likelihood of later unpleasant surprises. This can include:

  • A review of the prospective issuer or target’s internal anti-corruption policies and procedures, if any. Focus on the scope and substance of such policies and procedures, as well as the manner of their implementation and oversight. Consider whether the target has implemented rigorous compliance processes that provide for effective anti-corruption risk assessment, education and training, review and monitoring of agents, consultants and other business partners, internal and external reporting, record-keeping and other measures for detecting and deterring violations of the CFPOA and other anti-corruption laws.
  • A review of the prospective issuer or target’s corporate books and minutes with an eye towards matters potentially requiring further inquiry. This includes unusual or unexplained corporate transactions, such as the issuance of founder shares to unexplained or unrelated individuals, unusual business development trips or business development expenses, or sizeable but unexplained foreign expenditures.
  • A close review of the terms and circumstances of all agency, consulting or joint venture agreements and other business relationships entered into in connection with the pursuit of government contracts or other investment contracts, including a review of the representations and warranties regarding compliance with anti-corruption laws and further investigation into the principals of such agents and business partners, including their credentials, related experience and any potential connection to local public officials.
  • The negotiation of representations, warranties, conditions to closing and indemnities in the underwriting agreement, asset purchase agreement or share purchase agreement, as applicable and prudent in the circumstances considering possible corruption issues raised by due diligence procedures and depending on the nature of the transaction, whether a financing, an acquisition or otherwise.

Understanding the Impact of Corrupt Practices on Foreign Assets and Operations

Corrupt practices can result in more than fines under anti-corruption legislation, such as the CFPOA, or civil liability to shareholders or related third parties: such practices can also operate to undermine the rights and benefits to which a company is entitled in a foreign jurisdiction. Due diligence of the company’s assets and operations should therefore include, amongst other things, the consideration of:

  • The degree to which the company’s assets and operations are dependent on government contracts or other investment contracts, whether with the state itself, a state agency or a state-owned entity. In the international resource sector, for example, this would include mining concessions, government-issued oil and gas licenses or production-sharing contracts, and service contracts executed with state firms.
  • The termination provisions of relevant government contracts and investment contracts, as well as the rights of the company in respect of same. For example, might corrupt practices by the company provide the host state a unilateral right of termination, and is such a right subject to challenge by the company under the dispute resolution provisions of the contract?
  • The law governing such government contracts and investment contracts. It is not uncommon for investment contracts in the developing world to apply the law of a foreign jurisdiction or to supplement the law of the host state with applicable provisions of international law. Furthermore, these different bodies of law may take different approaches to corrupt practices, including potentially making contracts secured by illicit means void ab initio or voidable at the election of the host state.
  • The general legal investment climate in the host state as well as the respect by the host state for the rule of law. Does the company have access to the investment protection provisions of an investment treaty executed by the host state, whether bilateral or multilateral such as the Energy Charter Treaty? Do the investor standing provisions of such treaties directly address matters relating to corrupt practices? Does the host state have investment protection provisions written into its domestic investment law, including consent to the arbitration of investment disputes? Is the host state a signatory to the ICSID Convention? Does the host state have a history of resource nationalism?

Summary

Many anti-bribery investigations and convictions, particularly under the United States Foreign Corrupt Practices Act (FCPA), have been the result of potential violations discovered during the due diligence phase of financings and M&A transactions.

A company’s failure to have appropriate compliance measures in place can raise significant corruption risk, thereby affecting the terms of financing or the purchase price or, in some cases, causing the entire deal to disintegrate. Companies should be prepared for the additional scrutiny to be applied in this respect going forward. Furthermore, if it hasn’t already, any Canadian company engaged in cross-border transactions should carefully review its anti-corruption policies and procedures, including effective due diligence, to ensure full compliance with the CFPOA and, to the extent applicable, the FCPA and the United Kingdom Bribery Act. Such companies should also be fully aware of the various risk mitigation strategies available to them, whether under contract, treaty or otherwise.

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