Companies and private equity funds looking to complete or pursue acquisitions, investments, financings or other transactions involving a Russian or Ukrainian element will have to respond quickly to the challenges created by the escalating conflict in the region. With fresh volatility in the market and the uncertainties created by the Ukrainian crisis, investors are reconsidering their strategy for the region. Not only is the Ukrainian crisis likely to jeopardize completion timelines for ongoing cross-border transactions in the region, but the fate of many, if not most, of these transactions is hanging in the balance altogether. This article highlights some of the key areas of focus for parties looking to get their M&A deal across the line.
Sanctions: Is the deal permitted under the current sanctions regime? Dealing with persons (or entities under the control of persons) who are or may become subject to sanctions during the transaction process.
Deal teams will need to assess carefully whether a proposed transaction is permitted under EU/UK/U.S. sanctions, as well as increasing Russian counter-sanctions. Russia’s presidential order prohibiting foreign entities from divesting interests in Russian businesses makes a number of ongoing divestments of energy companies look like a long-term play. Further, consider Roman Abramovich’s unsuccessful attempt to protect Chelsea Football Club by handing ownership to the trustees, and the subsequent announcement that the Club will be put up for sale, with the proposed $3bn price tag now considered to be aggressive by many.
The quickly evolving sanctions regime means that any assessment will need to be regularly refreshed. The resulting uncertainty is likely to have a cooling effect on the M&A market for Russian assets and non-Russian assets owned or part-owned by Russia-related parties. Where transactions do go ahead, parties will need to protect themselves against the risk of post-signing changes to the sanctions regime that could prevent parties from closing the deal or making payments to sellers, including escrowed amounts and deferred consideration.
Dealing with persons (or entities under the control of persons) who are or may become subject to sanctions during the transaction process can be challenging for many reasons, including:
- Limited bidder universe: As investors rethink their investment strategy, sellers looking to exit a business with operations in the region or connected with Russian interests may be faced with a restricted number of potential buyers, which is likely to impact valuations. Companies headquartered in NATO countries and elsewhere may face difficulties in going ahead with their announced or planned transactions with Russian counterparties or targets.
- Overseas joint ventures: Many deals relating to Russian assets are structured as joint ventures, with the investment vehicle incorporated overseas, including commonly in Cyprus, the Netherlands, Luxembourg, Malta or Switzerland. Even though the primary holding companies may be outside of Russia, or indeed may even be in Europe, transactions to divest stakes in these entities will still be impacted by sanctions regimes—for example, a joint venture partner may potentially be blocked from acquiring the interests of Russia connected partners or selling its stake to them, and potentially interested third party buyers of a non-Russia connected party’s stake will tread more carefully in light of the potential legal and reputational risks of investing in Russian assets or alongside Russian partners. The imposition of sanctions on one partner may also trigger default or breach provisions, potentially triggering exit/buy-out mechanisms.
In addition, there are also legal and reputational risks for parties that remain in these joint venture arrangements; even if the business itself is not directly subject to sanctions, involvement in business connected with Russia or alongside parties connected with Russia will be a red flag to both banks and business partners. Many of the same considerations will also apply to joint ventures with Russian partners involving non-Russian businesses and assets.
- Consideration: Assuming that a transaction is permitted to close, the seller will be keen to ensure that all contractual payments are front-loaded to the maximum extent permissible, given the risk that new sanctions may make certain payments unlawful, including minimizing the gap between signing and completion and avoiding deferred consideration or significant holdbacks or escrow. Conversely, if purchasing assets from a Russian connected entity, it will be important to assess whether any transfer of funds to such party is permitted.
- Recourse against sellers: Usual contractual protections, including recovery for breaches of warranties and indemnities may be limited, if the seller is subject to sanctions or the buyer is unable to receive funds from the seller. It is unlikely that parties will be able to obtain warranty and indemnity insurance with respect to transactions involving the region. Further, it is not yet clear what the impact will be on insurance on transactions in neighboring countries. If insurance is already in place, parties will need to look carefully at the exclusions and carveouts in their policy terms to check whether recovery is excluded for loss arising as a result of war or conflict.
Financing the Deal
Obtaining new financing for transactions involving assets (or parties) in the conflict region is going to be extremely challenging. Further, parties will need to look carefully at existing financing arrangements, to assess whether there has been an event of default under those arrangements, which may include failure to make payments and/or financial covenant breach (for example, the impact of devaluation of the ruble on financial ratios involving a foreign currency element). In addition, financings involving Russian banks, particularly if they are on the sanctions list, will need to be examined, even if they are simply members of the lending syndicate. Refinancing those facilities is likely going to be very difficult for some time to come.
It will be extremely important to have any existing financing arrangements in Russia or the Ukraine, or indeed in any neighboring countries in Eastern Europe, reviewed to assess potential exposure and default risks. Similarly, any new financings in Eastern Europe should be carefully thought through to take into account any spill-over risks.
Due Diligence: What are the commercial issues?
In the due diligence phase, buyers will have an enhanced focus on the impact of the conflict on supply chain, imports and exports, and currency controls, as well as business continuity (all of which are likely to be impacted for some time after the end of the conflict), insurance and risks to material contracts. Long term key contracts may include material adverse change, change in law or political force majeure elements which should be carefully analyzed in the context of the current crisis and legislative and regulatory responses. In addition, potential investors will be focused on compliance risks, including AML/KYC and sanctions compliance, as well as counterparty risk and governance risks associated with a potential investment (including with respect to legal requirements in Russia requiring locals to have substantive control). Enhanced focus on all of these issues is likely to translate to expansion of timelines.
Material Adverse Change (MAC) Clause: When should a buyer have the right to walk away?
A material adverse change (MAC) provision often gives a party the right to walk away from a transaction prior to closing if certain events occur that have a detrimental effect on the target’s business. MAC clauses typically apportion general market or industry risks to the buyer and target-specific risks to the seller. Parties typically invest time and effort in negotiating and carefully crafting MAC clauses to cover specific (and generally limited) circumstances in which the buyer should have a right to walk away from a transaction. In reality, MAC clauses are rarely used and even more rarely upheld by courts. Consequently, they should not be relied on by the buyer as an “easy exit” in the event that circumstances change between signing and completion of a deal. For existing contracts, unless the target was somehow disproportionately impacted by the conflict, most common MAC provisions would prohibit a termination. With respect to future contracts, it is likely that sellers will take the view that the conflict is a known and assessable risk for the buyer and, as it happened with COVID-19, insist on carving associated risks out of the scope of the clause.
Enforcement
It should go without saying that a contractual arrangement has no value unless it can be enforced. As is always the case when entering into a transaction, it is important to examine who the counterparty is. Importantly, do they have assets against which a judgment or award can be enforced and are these assets in a jurisdiction where enforcement can be readily made?
The conflict has also raised a question as to whether sanctions either from the West or Russia would impact any enforcement action, as well as whether local courts can be relied upon for fair and impartial treatment. Many transactions involving Russian counterparties or assets fortunately already utilize arbitration procedures, but even arbitration awards may need to be enforced by a court. Entities with existing contracts with Russian counterparties should review the dispute resolution mechanisms in their contracts to understand the impact of the crisis.
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Ukraine Crisis: Resources for Responding to the Impact of the Escalating Conflict
Our lawyers are actively engaged in advising clients on the full range of implications of the current conflict on their business and operations in Russia, Ukraine and globally. This includes advice on potential acquisitions and disposals of assets in Ukraine and Russia in light of the evolving sanctions regime, mitigating exposure to investments in Russia, managing legal and reputational risks for joint venture partners and commercial advice with respect to the impact on current business operations in the region. Our team includes lawyers with extensive experience representing clients on complex transactions and challenging situations in the region across a broad set of asset classes, as well as excellent relations with trusted local lawyers.
If you have any questions concerning the material discussed in this client alert, please contact the members of our Mergers and Acquisitions practice.
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