Jan.8, 2010

A number of features are emerging in the UK M&A market following the downturn in deal activity over the last year. Most notably, aside from sectors such as natural resources and commodities, which so far have been resilient to the downturn, many target businesses remain distressed, are divisions of a distressed group, or are in emerging markets in which local economic growth is stronger.   

In terms of process, where there are sales, there are fewer formal contested auctions, and where there are auctions, there are fewer bidders than there were two years ago. There are also more negotiated transactions occurring outside the traditional, investment-bank-driven auction scenario. As a consequence, buyers tend to have the upper hand in negotiations and transaction pace tends to be more measured. Buyers are proceeding cautiously while conducting deeper and more protracted due diligence investigations to verify valuation and to eradicate risk.

The nature of a target company as distressed—or as coming from or conducting its activities in an emerging market—heightens the need for thorough due diligence. In some cases, there may have been a breakdown in management effectiveness or, in a distressed-company situation, a reduction in necessary investment. In other cases, particularly in emerging markets, the company may have been operating in a jurisdiction that is regulated more loosely, thereby enabling questionable business practices.

As a consequence, compliance and corruption risk in cross-border transactions is being taken much more seriously in the United Kingdom and under English law. This is particularly true in light of the recent move toward consolidation of UK law in relation to money laundering and bribery offenses.

Buyers of businesses are exposed to potential liability twice with regard to UK legislation: first, during the due diligence process itself, if they become aware that the target has been conducting activities in relation to which the Proceeds of Crime Act 2002 (POCA) applies; and second, under new offenses that may be enacted following implementation of the Bribery Bill of 2009, which will replace common law and statutory offenses with a single piece of legislation and which will make prosecution by UK authorities much more straightforward.

Money Laundering

Although POCA is principally aimed at money laundering in relation to serious organized crime—it seeks to prevent money derived from terrorist financing, drug trafficking and serious organized crime from being "laundered" through legitimate commercial activities—the scope of the legislation in fact goes far beyond what most people would ordinarily regard as money laundering.

Two types of offense are created by POCA. The first offense includes the following:

Concealing, disguising, converting, transferring or removing criminal property from the relevant jurisdiction

Entering into or becoming concerned in an arrangement in which the person knows of or suspects or facilitates (by whatever means) the acquisition, retention, use or control of criminal property by or on behalf of another person

Acquisition, use or possession of criminal property

These offenses may be committed by anyone. A person has a defense to these offenses if he or she makes a disclosure to the UK Serious Organised Crime Agency (SOCA) and obtains appropriate consent.

The second offense applies to certain categories of advisors that have additional duties under POCA, including organizations and individuals such as lawyers, investment banks and accountants that are used as intermediaries in transactions. POCA defines all these organizations as being in the “regulated sector,” and they are required to notify SOCA of any money laundering activity which they encounter in the course of their professional activities.

UK money laundering legislation is specifically relevant to M&A transactions for the following reason: any asset is considered criminal property if it constitutes a person's benefit from criminal conduct. It is not relevant who carried out the criminal conduct, who benefited from it and whether the conduct occurred before or after POCA came into force. It is also irrelevant whether the person benefiting from the crime or otherwise engaged in the laundering knows or suspects that what he or she is doing constitutes money laundering. The only question is whether or not the person has benefited or is benefiting from criminal conduct.

The definition of criminal conduct in POCA is not limited to “serious organized crime.” This means that POCA not only covers “ordinary” criminal activity, it also applies to criminal offenses under UK law that would not ordinarily be regarded as being connected with money laundering. For example, in the United Kingdom, regulatory breaches will often constitute a criminal offense. This means that water pollution; company law offenses; competition law offenses; consumer offenses; food, health and safety law offenses; tax offenses; immigration offenses; and the failure to hold or obtain waste licenses are all considered criminal offenses. All of these “regulatory” breaches potentially fall within the scope of the money laundering regime, either because the cost of not obtaining the permit has been saved, an investment has not been made to comply with regulations, or the relevant tax has not been paid. In addition, the proceeds of the sale of the target itself would constitute a benefit to the seller derived from criminal behavior.

There is no materiality threshold contained in POCA. Therefore, given that the money laundering regime encompasses all criminal offenses, there is a real likelihood that in any M&A transaction, matters will be identified as part of due diligence that will require a disclosure to SOCA and receipt of appropriate consent in order to proceed. Even if a matter has no commercial significance because it is trivial or easily remediable, it may still need to be reported to SOCA. Professional advisers—as members of a regulated sector—are required by law to report the matter to SOCA, with failure to do so being an offense under POCA.

If, during due diligence, a buyer discovers regulatory breaches by a target company that technically amount to a criminal offense, what should it do? It should make a disclosure to SOCA requesting consent to proceed with the transaction, since doing so is a defense to the offense of money laundering, if the person makes an authorized disclosure and obtains the appropriate consent to commit the money laundering act before doing so.

Once the disclosure has been submitted to SOCA (usually electronically, through a law firm), SOCA has seven working days in which either to refuse or to grant consent to proceed with the transaction. If SOCA fails to respond within that period, it is lawful to proceed on the expiry of that period. If consent to proceed is denied, then SOCA has another 31 calendar days in which to take further action, during which period no further step in relation to the transaction may be taken. Consequently, it is possible that a party can be precluded from consummating a transaction for at least 40 calendar days. Generally, however, consent to proceed in relation to regulatory offenses and "technical" money laundering breaches are given before the initial seven working day period, and often within 24 or 48 hours. Consent may be given subject to the buyer undertaking to stop the relevant behavior, but consent will not protect target management who may have been engaged in the related activities.

It is, however, essential that the transaction is not signed before an authorized disclosure is made and appropriate consent is obtained—otherwise a criminal offense in the United Kingdom will be committed.

Can the buyer notify the seller, target or its advisers of the state of affairs? No, it cannot, as it is considered a “tipping off” offense for the buyer or its advisers to inform the seller of their knowledge or suspicion that a money laundering offense has been or is in the course of being committed. This is designed to avoid prejudice to any potential criminal investigation. Instead, the only permitted course is for the buyer and its advisers to make disclosure to SOCA and to seek consent to inform the seller. It may well be the case that the seller's advisers have already disclosed the criminal conduct to SOCA so that they can continue with the transaction on behalf of the seller.

In terms of publicity following a disclosure to SOCA, there is no duty on SOCA to keep the matter confidential and, typically, there is no public disclosure of the matter. SOCA is also under no statutory duty to disclose whether it proposes to investigate the matter itself or whether it has notified another agency of the matter. Finally, SOCA is not obliged to inform anyone whether it considers the matter closed.

Bribery Bill

The Bribery Bill, which is likely to come into force in the United Kingdom during 2010, draws together a number of disparate common law and statutory offenses into one coherent piece of legislation and has been drawn up following widespread criticism that the UK authorities were not taking adequate steps to combat abuse in commercial transactions. This new legislation will make it more straightforward for UK authorities to prosecute bribery in business transactions and will be among the most comprehensive anti-corruption laws in the world. It will create the following new offenses:

Offering, requesting or receiving bribes by individuals or companies

Bribery of foreign public officials

Negligent failure by companies to prevent bribes being paid on their behalf

Criminal liability for senior management where their companies carry out bribery with their consent or connivance

These offenses apply to UK individuals, companies and residents, and cover foreign individuals or corporations where an offense is carried out in the United Kingdom. The legislation, which will apply extra-territorially, will go well beyond the scope of the U.S. Foreign Corrupt Practices Act of 1977, since it applies to bribery of any individual and not just foreign government officials.