Tips for M&A transactions in the Middle East
April 2018 | PROFESSIONAL INSIGHT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
April 2018 Issue
This article sets out some of the common issues faced by parties purchasing entities based in the Gulf Cooperation Council (GCC), with a focus on the Kingdom of Saudi Arabia and the United Arab Emirates (UAE).
Purchasers and regulatory issues
If a purchaser has any non-GCC national ownership at any level of its equity capital structure, time will need to be spent confirming whether the target sector is open to investment in the applicable jurisdiction. In addition, purchasers will need to confirm whether any limitation applies to non-GCC nationals as well, or to nationals of the country in which investment is being undertaken, and the relevant percentage which can be acquired by, as applicable, a ‘non-GCC’ purchaser or a national of a country other than the country in which the activity is being undertaken.
For example, in Saudi Arabia, a non-GCC investor can directly acquire an interest in a hospital with more than 100 beds or in an entity manufacturing medical devices, but cannot directly own a stake in a medical or dental clinic as healthcare clinics in Saudi Arabia can only be owned by Saudi nationals. In addition, non-GCC national investors can, subject to a number of narrow exceptions, acquire no more than 75 percent of businesses engaged in wholesale or retail sale of goods, including consumer goods, but only Saudi nationals can own an interest in an entity which has registered its distribution agreement with the Ministry of Commerce and Investment.
In both the UAE and Saudi Arabia, additional limitations will apply to quite a few other commercial activities including, among others, retail pharmacies, education, logistics and security services. Even with regulatory hurdles, counsel should be able to explore alternative legal means through which a purchaser can acquire an economic interest in a target in such sector through alternative legal investment structures such as a fund or sukuk.
Purchasers should shy away from typical nominee structures that may result in a party running afoul of relevant anti-fronting legislation. Depending on the jurisdiction, if the fronting arrangement is reported, the parties involved could face civil or criminal penalties. For example, the stated objective of the UAE Anti-Fronting Law is to prevent non-UAE nationals – whether natural or juristic persons – to practice any economic or professional activity that is not permissible for them to practice in accordance with the law and decrees of the UAE.
Despite the existence of such laws in Saudi Arabia and the UAE, some lawyers have advocated for the use of simple side agreements. We are aware that certain lawyers in the UAE often point to the fact that there is actually evidence that the highest courts in the Emirates of Dubai and Abu Dhabi have historically upheld ‘side’ agreements and focused on the economic rather than statutory relationship of the parties. Moreover, the argument has also been repeatedly made that if ‘side’ agreements were invalidated, it would result in adversely affecting foreign investment in the UAE and would be contrary to various declarations by the governments at the federal and emirate level that the UAE is encouraging foreign investment.
We note, however, that the Union Supreme Court in Abu Dhabi in late 2012 decided that ‘side’ agreements are not valid and any agreement to vary the economic or other rights of the shareholders in a UAE joint venture should be in the registered articles and be recognised by a local notary public and undergo the normal recognition of the licensing authorities in the relevant Emirates. While this case does not have precedential value in creating binding precedent as in a common law jurisdiction, foreign parties need to be mindful that there are examples of the judiciary invalidating such agreements and that such ‘side’ agreements likely violate the anti-fronting law. Moreover, there are often legal means of achieving economic control. For example, in the Emirate of Abu Dhabi it is possible to have the registered articles provide that the foreign 49 percent registered owner is entitled to at least 90 percent of the dividends.
Furthermore, in Saudi Arabia, the Ministry of Commerce & Investment regularly posts advertisements in the local press offering bounties for parties who turn-in participants in fronting arrangements, and prosecutes parties violating the Saudi Arabian Anti-Fronting law. We also understand that auditors in Saudi Arabia are now required to report the extent they are aware of not only registered owners but of ‘beneficial’ owners of a business in their filing with the General Authority for Zakat & Income Taxation. Finally, there are greater demands and a higher level of liability on directors under the new companies laws in Saudi Arabia and the UAE and such directors should carefully review the legality of the ownership of companies and operation of such companies prior to agreeing to act as directors. We are seeing an uptick in prosecutions for parties involved in fronting arrangements.
Nominee owners and other third parties
As with many other sectors, quite a few healthcare, education and food & beverage transactions involve the participation of either nominee owners or historically passive owners. We often find that when such owners become aware that a private equity group, strategic investor or fund is keen to acquire the underlying business that such nominees or passive owners suddenly wish to become actively involved and expect to sell their shares at a significant premium.
From a practical perspective, in a UAE or Saudi limited liability company one shareholder cannot sell without the participation of all other shareholders. If one party does not participate in the sale by being present at the notary public, they can effectively hold the transaction to ransom until they feel they are adequately compensated. Also, indemnities should be carefully crafted to address issues which may arise as a result of a previous nominee owner being deemed to have been in violation of the relevant jurisdiction’s anti-fronting law. Purchasers will often want to ensure they are indemnified for the legal violations as a result of the way in which the previous owner held the asset.
Preparing and negotiating a detailed term sheet
Purchasers often wish to enter into a term sheet, memorandum of understanding or offer letter before documenting a complex share purchase agreement and, if applicable, shareholders’ agreement. We find, however, that parties can sometimes gloss over key terms at the offer letter stage and, accordingly, do not have a true ‘meeting of the minds’ which can lead to significant resources being expended on a deal that was never truly agreed. For example, we find parties will agree to certain points in a term sheet and not consider the fact that they may not be enforceable, such as transaction structure, drag-along or tag-along provisions, reserved matters in the registered articles, scope of warranty, representation, indemnity coverage and contingent consideration, if any. By spending more time at the term sheet stage, parties can ensure that there is a clear understanding of the requirements of both purchasers and sellers.
Agreeing to exclusivity
A company that is in negotiations to sell a minority or majority stake to a reputable purchaser may attempt to shop an offer letter to other potential purchasers. Despite confidentiality clauses, the Middle East is a relatively small market and other potential buyers will likely inevitably learn that a stake in a company is for sale. Therefore, it is critical that the concerned buyer negotiate a well drafted exclusivity clause with an enforceable termination or break-fee if sellers breach the exclusivity arrangements.
In addition, depending on the governing law used in the offer letter, parties should consider whether a provision requiring parties to negotiate in good faith should be included in the offer letter. We have seen purchasers successfully demand payment of a break-fee when a seller changes its mind or pursues new purchasers. Depending on the governing law and jurisdiction used in the term sheet, the break-fee can set out liquidated damages in which case it should be carefully crafted so as to not be interpreted as an unenforceable penalty.
The Saudization programme
Since the launch of Saudi Arabia’s Nitiqat Saudization programme, labour-intensive businesses have faced challenges trying to comply with the programme without significantly increasing their overheads. In general, the programme categorises all businesses as either ‘red’, ‘yellow’, ‘green’ or ‘platinum’ depending on the number of Saudi nationals employed by a company and the job description of its employees, with a certificate being issued by the Saudi Ministry of Labor setting out each company’s current status. Depending on the colour-coding of a target company, the Ministry of Labor will provide certain incentives or penalties; for example, residency visa processing and renewals are quicker for ‘platinum’ companies, while such services are not permitted for ‘red’ companies. Thus, a purchaser should be prepared to invest in a Saudization programme to recruit and train Saudi nationals.
Purchasers should be aware that while competition approvals have been a longstanding feature of M&A transactions in many jurisdictions, the competition approval processes in most regional jurisdictions are relatively new and untested. That said, both Saudi Arabia and the UAE have competition authorities to which certain transactions must be submitted and approved as a condition to closing.
Governing law and jurisdiction for disputes
Not infrequently, a foreign buyer will agree to arbitration in London to settle any disputes arising under its transaction documentation – whether the sale and purchase agreement or shareholders’ agreement – and perhaps will even agree to use English law as the governing law for the shareholders agreement. A foreign shareholder may initially feel elated at this ‘win’, but, if a dispute arises, the elation may be shortlived as there are only a handful of recent examples of arbitral awards rendered outside of the GCC countries ever being enforced in the UAE or Saudi Arabia.
It may be preferable for the foreign partner to carefully consider whether to have the arbitration conducted in the English language under the DIFC-LCIA rules with a Dubai International Financial Centre (DIFC) seat or under the new Saudi Arbitration regulations. While we have seen acquisition documentation being governed by one law, English law, and, to the extent applicable, a shareholders’ agreement being governed by another law, UAE or Saudi law, parties should discuss with counsel the benefits and detriments that a particular governing law and jurisdiction can have on their transaction. Parties should also be mindful that the official language of the GCC is Arabic and should consider adding provisions in the relevant agreement to solely appoint a licensed translator in the event such documents require translation.
The ADGM and DIFC
Because the articles of association of limited liability companies incorporated on-shore in the UAE and in Saudi Arabia do not permit a great deal of flexibility or customisation, purchasers acquiring less than 100 percent of a target will typically enter into a separate shareholders’ agreement setting out, among others, buy-sell provisions, or put and call options, or restrictive covenants, reserved matters and, importantly for private equity, a detailed exit process. While much time can be spent negotiating such provisions, it is important to note that courts in the UAE or Saudi Arabia rarely, if ever, grant specific performance – which is to say that they will rarely force a party to a dispute to, for example, transfer their shares in accordance with a buy/sell provision. Instead, such courts may choose to award money damages which would lead to a discussion as to the quantum of harm done, if any, by the breaching party to the non-breaching party.
One common provision in many shareholders’ agreements which deals with ‘deadlock’ in decision making, or serious disputes between shareholders, is to provide for a buy-sell mechanism, whereby one party names a price at which the joint venture interest could be bought or sold. The other party may either buy out or sell to the first party at the named price. Another common provision is the concept of dilution: if one partner refuses to contribute equity capital as needed, the other partner can contribute and dilute the interests of the first, possibly removing some voting rights or board representation in the process. Neither of these provisions will be enforced by the Saudi Arabian courts.
Buyers should consider moving all or part of their acquisition structure to an offshore jurisdiction such as the DIFC or the Abu Dhabi Global Markets (ADGM) financial freezone. We have found that many GCC jurisdictions, including Saudi Arabia, Kuwait and Dubai, view the ADGM and the DIFC as being ‘GCC national’ to the extent such entity is GCC owned. Accordingly, parties can take advantage of the greater number of sectors open to GCC national investment and, in certain circumstances, better tax treatment by using these vehicles as opposed to, for example, a Cayman company. In addition, the UAE has a robust tax treaty network which could lead to significant tax benefits if the transaction is well structured.
Another primary benefit of establishing a joint venture vehicle in the ADGM or the DIFC is that the ADGM has adopted English law and the DIFC has utilised English law as a source of much of its legislation. Accordingly, parties can take some comfort that provisions which are enforceable under English law will also be enforced for ADGM or DIFC entities. In addition, parties can entrench provisions such as put and call options, dilution or anti-dilution provisions, multiple classes of shares, enforceable employee stock option plans, reserved matters, pledges of shares, etc., in the constitutional documents of entities established in the ADGM or the DIFC.
Transaction structuring and eventual exit
A buyer must carefully consider its structure for making an investment. Buyers should create a structure that will maximise exit options. For example, a party outside of Saudi Arabia that holds shares directly in an unlisted company will be subject to a 20 percent capital gains tax on exit. By creating another special purpose vehicle (SPV) between the buyer and the target company, such capital gains tax can be eliminated, resulting in a much lower taxation on exit. A buyer may also wish to agree upfront with the seller and remaining shareholders how an exit will work or the need to convert the company to a joint stock company for an eventual initial public offering.
To protect their rights, investors should retain experienced counsel who understand regional considerations and can advise upon the optimal structure and deal terms when advising upon their transactions. Knowledge of both local laws and how they are enforced or practically applied and international best practice are key in order to ensure a successful transaction.
Osama M. Audi and Nabil A. Issa are partners at King & Spalding. Mr Audi can be contacted on +971 (4) 377 9934 or by email: email@example.com. Mr Issa can be contacted on +971 4 377 9909 or by email: firstname.lastname@example.org.
© Financier Worldwide
Osama M. Audi and Nabil A. Issa
King & Spalding