Avoiding successor liability in M&A transactions




Imagine a relatively straightforward transaction: an expanding company acquires an attractive target that promises lucrative access to customers in emerging markets. Among the target’s key assets are agreements with state-owned companies in those markets which allow it to deliver services at unmatched rates almost too good to be true. Within weeks of closing the deal, the acquirer uncovers questionable payments by the target to foreign officials, prompting a companywide internal investigation that eventually leads to voluntary disclosure of violations of the US Foreign Corrupt Practices Act (FCPA) to the relevant authorities. Within a year of the acquisition, as the cost of the investigation and penalties mount, the acquirer is forced to write off its entire investment.

This nightmare scenario is far from fiction – it was the situation executives of eLandia International faced in 2007, shortly after its $20m acquisition of Latin Node, a provider of wholesale telecommunications services. Despite Latin Node’s representations to the contrary, it became apparent after closing that the target’s reduced-rate agreements with state-owned enterprises in Yemen and Honduras were obtained by paying approximately $2m in unlawful bribes to public officials. eLandia’s losses included a fine of $2m levied by the US Department of Justice, the costs of terminating Latin Node’s executives and eventually of winding down the entire entity, the cancellation of millions of dollars’ worth of contracts with customers and vendors, and hefty legal fees related to the investigation. Within just months of its celebrated acquisition, it found itself left holding the bag as its entire investment was eviscerated.

Understanding the FCPA

As eLandia’s missteps illustrate, acquirers must be cognisant of the dangers of purchasing a target’s FCPA violations hand in hand with its assets or face potentially devastating consequences. Enacted in 1977, the FCPA prohibits payments or anything of value to foreign officials to obtain and/or retain business. Navigating the Act’s prohibitions can be treacherous, especially as courts and enforcement authorities have interpreted the FCPA in an increasingly broad manner. The Act applies to ‘domestic concerns’, entities and individuals with unambiguous ties to the United States – citizenship, residency and incorporation, among others. The Act also applies to ‘issuers’: executives, employees, and affiliates acting on behalf of any company – domestic or foreign – having shares listed on a US stock exchange. Even non-US companies that simply transact business with US banks are potential targets of FCPA enforcement actions. Their seemingly incidental exposure to US jurisdiction leaves foreign companies at particular risk of prosecution: eight of the 10 largest FCPA penalties have been levied against non-US companies. The sweeping scope of the law underscores the need for companies of all stripes to be mindful of its prohibitions and potential pitfalls.

The FCPA additionally mandates that publicly listed companies maintain accurate books and records of their transactions and that they also have adequate controls to ensure transactions are only executed with appropriate authorisation and pursuant to company policy. US authorities often target large multinational corporations with insufficiently managed subsidiaries for running afoul of these provisions. For example, in 2007, Dow Chemical was held in violation of the books and records provision of the FCPA in connection with actions of a fifth-tier subsidiary in India. Although the parent company neither knew of nor authorised the subsidiary’s allegedly corrupt payments, Dow was nevertheless held responsible in a Securities and Exchange Commission (SEC) enforcement action.

Over the last decade, US authorities have allocated increasing resources to FCPA investigations and prosecutions, creating an environment of increased scrutiny of deals and record-breaking penalties following violations. In the largest FCPA enforcement action in history, Siemens paid approximately $1.6bn in combined penalties, fines and disgorgement to the Department of Justice, the SEC and relevant authorities in Germany relating to an alleged scheme of corruption that spanned the globe. Just this year, former Siemens executives were hit with over $900,000 in individual civil penalties and disgorgement relating to the same case – again the largest penalty of its kind in history. And the longest prison sentence ever in an FCPA case was handed down in 2011, when the former president of Terra Telecommunications was given 15 years for his role in a scheme to bribe Haitian government officials.

Navigating FCPA risks in M&A transactions: avoiding potential successor liability

In a climate of heightened enforcement and increasingly severe penalties, companies must recognise that mergers, acquisitions and similar types of business combinations are particularly fraught with FCPA-related dangers. Acquirers often have limited access to the information needed to accurately assess a target company’s corruption-related risks, yet enforcement authorities frequently hold them accountable for both pre- and post-closing violations. To responsibly confront the potential consequences of this uncertainty, acquirers must not only investigate and disclose FCPA violations as soon as practicable, but authorities also expect them to put a plan in place immediately upon closing to ensure no illegal payments occur after a merger. However, authorities have also recognised the limitations buyers often face when confronted with limited access to a target’s books and records. In a 2008 opinion release responding to an inquiry from Halliburton during its acquisition of Expro, the Department of Justice announced a safe harbour of 180 days after closing to investigate, disclose and remedy problematic conduct.

In a demonstration of this principle, in 2011, Ball Corporation settled an SEC enforcement action based on the questionable payments of a recently acquired subsidiary in Argentina. Although Ball identified these pre-closing violations soon after the acquisition, the SEC nevertheless found the company liable for them, particularly because of Ball’s failure to put measures in place at the subsidiary to safeguard against future violations following the acquisition’s grace period.

In contrast, Pfizer’s 2009 acquisition of Wyeth, which also uncovered corruption concerns, led to favourable settlements with the SEC and Department of Justice absolving Pfizer of liability for Wyeth’s conduct. Pfizer secured this settlement by promptly reporting Wyeth’s conduct to authorities – in accordance with the 180-day safe harbour – as well as by making a substantial effort to promptly integrate Wyeth into Pfizer’s existing FCPA compliance framework.

Avoiding liability: risk assessments and anti-corruption due diligence

The very real costs of acquiring a target’s FCPA violations in an environment where authorities are all too eager to critically examine pre- and post-closing conduct underscore the necessity of FCPA-specific due diligence as a routine part of the overall due diligence process. Buyers must first assess a deal’s FCPA-specific risks that may warrant further review. Such risks include whether the target does business in countries at high risk of corruption; the level of government involvement in the target’s industry (e.g., via licences, customs duties, regulatory oversight, or as customers); the target’s business model and type of transactions (e.g., heavy reliance on third-party agents and brokers); the sufficiency of the target’s internal controls and compliance policies; and any previous corruption-related investigations or allegations against the target.

Beyond potentially mitigating civil and criminal liability exposure, effective due diligence can significantly affect the course of the deal itself. Discovering ‘red flags’ or questionable conduct during the diligence review can prompt the parties to adjust the deal terms accordingly. Do relationships that affect the target’s revenues need to be terminated? Should the buyer request indemnification against civil actions or other potential penalties? Are additional representations and warranties regarding FCPA-related risks, such as foreign official involvement in the company, advisable? How are responsibilities and costs for corruption investigations to be allocated between the buyer and the target? Such questions can raise important concerns regarding the valuation of the target and help shift the costs and responsibility for violations away from buyers.

US authorities expect both effective anti-corruption due diligence prior to mergers and acquisitions, as well as adequate post-merger integration of a target into a larger anti-corruption framework. Despite the sometimes time-consuming and costly nature of these actions, such reviews can significantly protect the interests of shareholders and executives against an environment fraught with risk. Staggering penalties and costs, reputational damage, individual prosecutions and illusory valuations built on a foundation of corrupt practices are all potential pitfalls of inadequate FCPA-specific due diligence. In an environment of heightened regulatory scrutiny, companies must aggressively take steps to avoid these pitfalls, or face the not-so-illusory prospect of the unscrupulous practices of a target wiping out a key investment.


Paula Howell Anderson is a partner at Shearman & Sterling LLP. She can be contacted on +1 (212) 848 7727 or by email: paula.anderson@shearman.com.

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Paula Howell Anderson

Shearman & Sterling LLP

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