Sanctions considerations in cross border transactions

Viewpoints
March 8, 2024
2 minutes

I am pleased to once again have had the opportunity to co-author a section of Control Risks’ annual sanctions report, discussing sanctions risks in cross border transactions.  

Together with Henry Smith (Partner, Control Risks), we highlight through an illustrative case study how recent geopolitical and other developments have added further complexity to executing cross-border acquisitions and that bespoke diligence strategies designed to the specific facts and risks posed need to be considered.

Case study

A U.S. private equity firm is considering acquiring an Italy-headquartered, family-owned paint manufacturer. The manufacturer sells products through distributors in Europe and the Middle East, with some continued sales through a wholly-owned subsidiary in Russia. It has suppliers in both China and Europe. 

Russia considerations

In addition to reputational considerations, continued business in Russia would prompt consideration of the specific nature of the target’s products, their end uses and users, and intermediary banks used for transactions. Through the diligence process, we would seek to understand the ownership and control status of the target’s customers, the use and potential diversion of products, and continued compliance with applicable sanctions post-invasion.

Even if diligence does not indicate any historical or ongoing sanctions violations, we would anticipate the buyer may consider a potential divestment from Russia (and we would want to consider whether this may create second order losses in income in the event that the Russian business was responsible for  sales into other markets). 

Circumvention risks in the Middle East

Revenue data shows a spike in sales in Turkey over the past two years, largely through one of the company’s Turkey-based distributors. Turkey only appeared in the target’s top five sales markets this year – for which the target was unable to provide a clear commercial reason – and the relevant distribution agreement lacks sanctions compliance clauses and territorial limitations.

An outside-in diligence process could investigate the distributor’s trading practices and onward-sales to sanctioned countries, as well as the target’s reputation within industry and government stakeholders in Turkey, to understand the reasons for the target’s growth in sales. In response, a buyer would likely want to improve third-party processes, including onboarding and monitoring. It may consider a post-closing review given the DOJ’s new M&A Safe Harbor Policy, which provides a presumption of declination for the acquiring entity for misconduct at an acquired entity identified and disclosed within six months of closing.

Geopolitical scenario planning

Interviews with management and review of the target’s policies indicate it has an immature approach to compliance risk and has not planned for potential supply chain interruptions stemming from future changes to the U.S.-China relationship.

A buyer would undertake a scenario-led assessment examining potential outcomes on the target’s business model and third-party relationships. Results would drive the implementation of improved monitoring and reporting of geopolitical risk to the Board.

Data breach

Near completion, a data breach occurs conducted by a criminal group to which the target is considering paying a ransom to return its data and regain access to its system. The buyer pauses the transaction to allow an investigation to identify hackers, backers and potential sanctions violations that may follow from any ransom payment made. Following a thorough investigation, the buyer clears these concerns and the transaction is approved subject to incident-related warranties and indemnities.

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