Corporate transparency

Most Western jurisdictions have less onerous governance and transparency requirements for privately held companies than those publicly traded on regulated stock markets.  This difference invariably affects the way that companies conduct their business relationships, whether they are negotiating commercial contracts, or engaging in joint ventures (JVs) or mergers and acquisitions (M&A).

But one of the most striking aspects of the Dubai C2C event was how opaque the internal governance of many local companies was – even in comparison to private companies in Western nations.

One speaker – whose employer had recently acquired a company based in Singapore – recalled how their company simply wasn’t used to “opening their books to the regulators”. Another recalled how they were trying to do a deal with another company – but the target company didn’t want to reveal its financial information as part of the due diligence process. Complex ownership structures – often involving extended family connections – and a lack of independently audited accounts left several Western counsel genuinely baffled on how to do business in the region. In some circumstances this meant that proposed deals either fell through entirely, or at a heavily discounted price. In other situations, the very nature of deals was reorganised, in order to reduce the acquiring company’s risk exposure – for example, a deal was structured as a straightforward asset sales, rather than as the sale of a business as a “going concern”.

For some local counsel, this situation was simply a matter of fact that they were used to working with. But for those speakers whose companies were governed by US anti-corruption legislation, accepting any lack of corporate transparency simply wasn’t an option. “Things that aren’t relevant to local companies are highly relevant to western ones,” said Liam McCollum, General Counsel, Middle East and Africa to GE. “If a Western company acquires a foreign company which has a connection to a government, the US Foreign Corrupt Practices Act (FCPA) needs to be considered. US companies are very aware of the reputational risks associated with such transactions.” Other speakers had resorted to unusual measures when evaluating a target company’s suitability for doing a deal – such as instructing corporate investigators to investigate the personal background of key directors, or any undeclared regulatory infringements the company had committed.

 

In general, speakers were divided about whether local companies would begin to adopt western-style working practices. Some thought that only companies who were now operating internationally, or are in need of international finance, would need to go down this route. Others suggested that the success of the DIFC – a Dubai free trade zone, largely regulated according to Western standards – indicated western regulations could work effectively in the country. “Although we are not a DIFC company our objective is to operate to full Western standards,” said Nick Hornung, General Counsel of Istithmar World, on one side of the debate. “Without a fully corporatised and transparent structure, we would struggle with a significant tranche of what we do. It wouldn’t be palatable to our international partners and counter parties.” GE’s Liam McCollum reinforced this opinion. “It’s because the DIFC is heavily regulated that many international companies have taken up the option of establishing branches there.” For the contrary position, Vanessa Abernethy, a corporate partner at the Dubai office of Simmons & Simmons, said: “all the feedback we get from family owned businesses is that, if they don’t need outside investment, they don’t need corporate governance reform.” However, she then added: “But companies who do have good corporate governance find it easier to attract and do business with Western companies”.

Cultural issues

Despite regulatory challenges for Western companies in particular, the UAE remains a country companies wish to do deals in. But several speakers from indigenous companies mentioned the cultural issues that western companies must be aware of, if deals are to succeed. One speaker recalled how a joint venture with a German company fell apart because of a fundamentally different approach to risk between the two stakeholders. “The German company was focused on certainty,” they said. “They wanted to know what we would be doing next month, next year, and what new products we planned to launch. In Dubai, we accept that there’s a lot of uncertainty, so the deal didn’t work out.”

The same speaker recalled how a memorandum of understanding for a new venture in Turkey had only been signed after a ‘fantastic kebab lunch.’ “Opening informal ways of communication during the deal negotiation helps you to close the deal,” he said. While this lawyer did have a sophisticated approach to running deals, he also found it essential for the two sides to a deal to get to know each other, and understand exactly what they wanted from the deal. “Most deals fail because the two sides have unrealistic expectations about what they will get out of it,” he concluded.

For companies used to working to stock exchange or investment bank-driven deal timetables, this emphasis on culture and “getting to know each other” may appear strange. But in fact, it may pay dividends for Western companies to engage in a prolonged courtship of a potential middle eastern business partner – not least because it could give time to discover any potential “deal-breakers” that might not become apparent during a typical due diligence process.

One speaker recalled how they had acquired a market leading company, only to discover that their distribution-based business model caused severe compliance difficulties, and had to be dismantled post-acquisition. “We ended up having to destroy a lot of the company’s value, and would never have done the deal - at that price, at least - if we had known how it operated.”  In a large-scale transaction such as this, this aspect of the company’s internal operations may not have been material enough to show up a typical new diligence process – but would have been a deal-breaker from an FCPA compliance point of view.  Had the company engaged in a more prolonged courtship prior to the acquisition, it may just have been possible that this issue would have been discovered, even via informal discussions with the target company’s management.

Running the deal process

As in many jurisdictions, several speakers expressed their frustration in trying to extract information from relevant stakeholders, which will be needed in preparation for a deal.  It was suggested that “education” may help alleviate this problem – that is, telling stakeholders why the information was needed, so they did not fear they were being investigated for some unspecified wrongdoing. However, other speakers said it simply was not always possible to be open with employees, because it may be essential that deal negotiations are conducted in secret. In those situations, counsel must simply use their power of persuasion – or rely on senior managers – to extract vital information from reluctant employees.

In any due diligence process, it helps if the acquiring company can clearly articulate which issues it regards as important, so the legal team can focus its efforts on addressing those issues. “Clarity on the scope of what issues are ‘material’ to a transaction can make a huge difference to a company’s legal spend on a due diligence process,” says Simmons & Simmons’ Vanessa Abernethy. “If our client comes to us with clear high-level objectives, we can wrap up the due diligence process much more quickly”.  Unfortunately, this best practice is not always followed, resulting in a wasted effort and unnecessary costs – and, in a worst case scenario, insufficient time spent investigating issues the acquiring company subsequently decides should be given the greatest attention.

Besides legal due diligence, the issue of tax and suitable tax structures was discussed at length by the Dubai C2C participants. One in-house counsel recalled how their tax advisors had devised a deal structure based on a DIFC-based holding company which, as soon as they heard about, they decided wasn’t acceptable from a local company law perspective. “I told them to go back and find another jurisdiction,” they said. With tax considerations central to the viability of many local deals, the need to devise structures that were both tax efficient and legally secure, occupied the minds of several of those around the table.

During this part of the debate, several speakers lamented the lack of high-quality tax advice offered by local law firms. This prompted a discussion of whether it would be preferable to instruct a local accountancy firm with an in-house legal capacity on major transactions, rather than a traditional law firm. This debate about the desirability - or otherwise - of multidisciplinary partnerships, of course, a matter that in-house counsel the world over must deal with. For their part, those private practice lawyers at the event were keen to stress their tax law capability within the region. To overcome the challenges of inconsistent legal and tax advice, one speaker recommended carrying out joint conference calls with representatives from the two professions, in order to ensure they were pursuing a consistent strategy.

Some of those around the tables worked in a transaction-driven environment, and offered their own best practices on how to run a successful deal. For example, Istithmar World’s Nick Hornung recalled how their company had a dedicated “investment board”, which was tasked by the company’s main board with reviewing and deciding upon investment and divestment related opportunities. The investment board examines all aspect of a potential deal – legal, operational and financial. Deal teams approach the investment board often multiple times during the course of a transaction, and only once key issues have been resolved will the proposal be approved by the investment board. “This could sound like a process tied up in red tape, but it isn’t,” he said. “Deals can be approved in a very short time, and deal teams understand the parameters required to receive an approval. If the investment board does not feel comfortable with a proposal it can be thrown out – even if the deal team has spent months working on it.”

Working with external law firms

The Dubai legal market is currently in a state of flux, with many western law firms now entering the territory. This development poses both challenges and opportunities for in-house counsel operating in the region. On the one hand, Western law firms tend to bring with them innovations such as online deal-rooms and legal news alerts – this second innovation is especially useful in a region lacking in legislative transparency. On the other hand, the arrival of transnational firms also tends to bring with it local market instability – with valued advisors occasionally jumping firms mid-transaction. Here, counsel often have a difficult decision to make – remain loyal to an individual, or to the firm.

One of the main advantages of engaging international law firms is, of course, their cross-border capabilities. International firms can often provide comparative law advice on how the same matter should be handled in multiple jurisdictions. But such law firms do have their territorial limits. Here, the question is what counsel should reasonably expect of international law firms in terms of their legal advice in countries where these firms do no have their own wholly-owned offices.

One speaker lamented paying hundreds of thousands of dollars for legal advice - only for the international law firms to supply a contribution from a third party law firm when asked to provide a vital legal opinion on Yemeni law. “The firm refused to countersign the legal opinion, leaving us with significant legal exposure,” they said. Unfortunately, such scenarios often place international law firms in a ‘no win’ situation.  While they may be willing to coordinate and manage the legal advice from a variety of different law firms, and ensure the appropriate quality of legal advice is provided, they may simply not be able to offer formal legal opinions in relation to laws they have no direct capability in. “There are clear risk management issues in relation to providing formal legal opinion letters in relation to those jurisdictions where we do not have qualified lawyers” said Simmons & Simmons’ Dubai projects partner, George Booth. He added that law firms can resource the expertise and ensure the legal opinion is of the requisite relevance and quality in such circumstances. Another speaker recommended that in-house counsel should actually do a “sense check” on the legal advice given to them by their external advisors. “If I’m not sure about a firm’s advice, it is my duty to get a second opinion from another law firm,” said session Chair, Fadi Hammadeh, who is Head of Legal at the Dubai Properties Group. “The role of in-house counsel should go beyond just managing advisors. Common sense should indicate when a law firm’s advice doesn’t sound right.

Dealing with the economic downturn

The final part of the session involved an extended debate on how the region would respond to a prolonged economic slowdown. Internally, several in-house legal departments were now under pressure to cut costs. Externally, several expressed concern about how the Dubai legal system would cope with any significant increase in corporate insolvencies. “Dubai insolvency laws have never really been tested before”, said GE’s Liam McCollum, speaking for several of the participants.

During the debate, several speakers engaged in a prolonged discussion about the economic slowdown was tantamount to a “force majeure” event, which may limit their obligations to comply with agreements that were no longer economically viable. Several expressed doubts that the current situation amounted to such an event – especially as the final ruling on this would almost certainly be left to a judge or other arbitrator. Others discussed whether that recent developments amounted to a “hardship situation”– but also pointed out that, once one company started relying on such provisions, their own clients could potentially do so against them – a potentially slippery slope, resulting in mutual mass recriminations.

In terms of defensive measures open to companies to protect their legal positions, several speakers offered suggestions, depending on where they were in the deal-making process. Where deals had not yet concluded, GE’s Liam McCollum suggested including robust cancellation payment provisions, to make it less economic for clients to attempt to walk away from agreed deals. Liam McCollum also suggested insisting on contracts requiring suppliers to notify their counterparts of substantial changes in their financial situation, perhaps in advance of a major order shipment. Where a company had recently acquired another, and the deal was not performing as planned, one suggested reviewing the previously agreed representations and warranties. While these agreements tended to be ignored once a deal had been signed, they might actually provide a useful legal and financial recourse in some situations.”

In some extreme situations, of course, a company’s clients may simply be unable to fulfill their side of the contractual bargain – no matter what legal safeguards had previously been included. “If you can’t enforce contractual terms you’ve spent six months negotiating, you may ultimately have to put the whole contract aside and negotiate the best deal you can,” said the Dubai Properties Group’s Fadi Hammadeh. Babu Mathew, General Manager (Group Legal) of the Al Futtaim Group, agreed: “Look for the warning signs, identify problem customers and negotiate as soon as possible. When things get really bad, there’s often no point trying to enforce existing contracts,” he said.

Takeaways

• Many local companies will have, to western eyes, opaque governance, ownership and financial record-keeping. A prolonged – and unconventional – due diligence process may be the only way to evaluate the company’s risk profile.
• An increasing number of Western law firms are beginning to establish in the region, which may bring with them a more familiar form of deal-making. But such firms can only advise on laws where they have “on the ground” capability – do not expect them to provide legal comfort outside these territories.
• As the world economic slowdown begins to affect the region, consider insisting on robust “material adverse change” provisions in your contracts – but recognise that they may not provide 100 per cent security.