Whilst once a “niche” issue in the context of M&A transactions, in view of the ongoing evolution and changes to sanctions regimes, dealmakers must now contemplate sanctions in every phase of the M&A transaction lifecycle.
In this article, we explore how sanctions impact key elements of the M&A transaction process for global insurers, including how dealmakers can navigate the impact of sanctions risks on a target business (“Target”) to preserve deal feasibility.
Due diligence
One of the most critical steps in the M&A transaction process is due diligence, where a buyer conducts investigations into the Target to understand the nature of the business or entity it is seeking to acquire. Conducting due diligence allows the buyer to make an informed decision as to whether the deal aligns with its risk appetite and compliance framework, and to inform on deal structure, Target valuation, and key contractual protections to mitigate risks.
In addition to the usual financial, legal, tax and commercial due diligence, buyers now look to conduct enhanced sanctions and compliance screening, which may involve scrutinising the Target’s financial records, examining ownership structures, and evaluating third-party relationships, the purpose of which is to uncover any links between the Target and sanctioned jurisdictions or individuals. If the buyer identifies any sanctions risks or exposure from its due diligence or screening, it may seek to re-negotiate deal value to account for the greater risk level or could require certain contractual protections in the transaction documents to mitigate such risks. In such circumstances, the seller should collaborate with the buyer to understand the identified risks and its concerns and/or agree appropriate contractual provisions or processes to mitigate those risks.
Contractual protections
M&A transactions carry inherent risks for the buyer, and whilst due diligence helps a global insurer to identify risks with the Target, those risks will then be reflected in the transaction documents through contractual protections. For insurers, this is particularly critical when navigating sanctions risks, which can have significant regulatory and reputational implications. Key contractual protections in this context include warranties, indemnities, conditions, and termination rights, each of which are discussed below.
Warranties
The seller gives warranties regarding the condition and operation of the Target. A buyer’s remedy for a breach of warranty under English law will be damages for loss arising from the breach of warranty.
Buyers are increasingly requiring sellers to give specific warranties in respect of the Target’s compliance with economic and trade sanctions. Penalties for sanctions violations include (i) fines (and it is reported that OFAC has previously issued nine figure fines); (ii) reputational damage and loss of clientele; or (iii) loss of licence or permission. As such, buyers want assurance from sellers that the Target carries no risk of sanctions violations and that it will inherit no serious penalties for such violations.
Indemnities
If a buyer’s due diligence investigation identifies any risk of sanctions violations, the buyer may also require indemnity protection for such risks to be included in the transaction document, which has the effect of allocating any sanctions-violation risk to the seller. Under the indemnity, the seller contractually promises to compensate the buyer or Target for any losses arising from violation of sanctions, including any penalties which may be imposed.
In terms of the scope of the indemnity, the buyer will likely require a broad indemnity in view of the severity of penalties for sanctions violations. However, it is typical for sellers to seek to limit indemnities to specific risks and impose financial and time limitations. Dealmakers should consider the nature and scope of the risk, as well as its likelihood to materialise, in order to negotiate a form of indemnity that is agreeable for both parties.
Conditions
Conditions are a pre-requisite to completion of an M&A transaction and provide a buyer with the right to terminate the transaction if the condition is not satisfied. Where a risk of sanctions violations is identified, the buyer may require dealmakers to negotiate and include specific conditions in the transaction documents to mitigate such risk, which may include:
- a condition requiring the seller to obtain a licence from OFAC (or similar body, as applicable) with respect to a specific business activity of the Target that would otherwise violate sanctions; or
- a condition that no material adverse sanctions related matter or event occurs in respect of the Target.
Termination rights
Termination rights are usually included in transaction documents which contemplate a split exchange/completion and provide both buyer and the seller with clearly defined circumstances in which the parties can lawfully terminate the transaction before completion.
In the context of sanctions, dealmakers may need to negotiate termination rights if a buyer (i) has identified any risk of sanctions violations; or (ii) reasonably requires a termination right due to any change to sanctions law and regulations, or to the list of sanctioned jurisdictions or persons, which is likely to affect the Target. Termination rights could be structured as:
- conditions precedent not being satisfied (as mentioned above under “Conditions”);
- termination in the event there is a breach by the seller of any warranty, undertaking or covenant relating to sanctions in the transaction document between signing and completion; or
- termination upon the occurrence of a material adverse change arising from a sanctions related matter or event. In this regard, it is common to see the concept of “material adverse change” extended to include specific references to sanctions related matters, such as violation of sanctions or changes to sanctions regimes.
W&I Insurance
Warranty and indemnity (W&I) insurance has also evolved to cover sanctions risks. If the W&I underwriter is made aware of any risk or impact of sanctions on the Target, it could increase or adjust the premium to account for such risk or entirely exclude coverage for liabilities arising from sanctions violations. In the event that coverage is excluded, dealmakers may find themselves having to negotiate sanctions risks into the transaction documents, whether as indemnities, warranties, or other provisions.
Conclusion
Navigating sanctions in M&A transactions requires global insurance dealmakers to adopt a flexible strategy. A Target’s exposure to jurisdictional sanctions can redefine negotiations, deal structure, and overall viability of a deal by triggering enhanced due diligence, requiring key contractual protections, or even leading to re-negotiation of the deal structure or value.For global insurers integrating sanctions analysis into every phase of the transaction process is essential to ensure regulatory compliance, protect reputation and to ensure that transactions remain viable in an unpredictable world.
