Sanction issues in M&A practice - update on DD requirements and transaction design

However, with Russia's attack on Ukraine and the subsequent rapid escalation of sanctions packages by the EU, US, UK and other countries and organizations, the issue of sanctions compliance has become a core topic of due diligence and a frequently decisive element of transaction structure and acquisition contract design.

One of the main reasons for this is that sanctions issues are of (possibly even existential) importance both at the level of the target company and at the level of those directly involved in the transaction, such as buyers, sellers and other parties such as investors, financing banks, W&I insurance companies, etc.

And yet the issue of sanctions is still not a matter of course for many economic players, especially in (apparently) only national transactions. Occasionally one is even confronted with a denial-approach, stating that sanctions regulations merely create "red-tape" whose non-compliance would not have any tangible negative consequences. 

Such an impression can indeed arise, as the consequences of sanction violations are not yet visible to the public in their full extent. Occasionally, there are media reports about particularly obvious sanctions violations and circumvention measures, which at least result in corresponding reputational damage for the actors concerned. However, the criminal consequences associated with violations of EU (and national) sanctions will only become visible in the media in a few years' time - once the investigations, indictments and convictions have been concluded. The competencies and personnel capacities required for the expected large number of proceedings have been created in Germany, in particular through the Second Sanctions Enforcement Act, the creation of the Central Office for Sanctions Enforcement, the Federal Financial Criminal Police Office and the FIU (Financial Intelligence Unit). It is therefore assumed that a tsunami-like wave of corresponding proceedings is currently building up.

Some of the current and immediate consequences of sanctions violations or inadequate sanctions compliance measures are still hidden from public view - but are clearly visible in our consulting practice. 

Banks in particular play a prominent role here. They are the ones who, through their compliance departments, which are highly sensitized by strict regulations on money laundering and combating terrorism, also uncover indirect sanctions violations - for example through subsidiaries in third countries. The declarations and evidence of internal sanctions compliance measures, process documentation and responsibilities required against the back-ground of the KYC documentation requirements and the necessary risk assessment make banks the key drivers in the enforcement of EU and, in particular, US sanctions requirements. 

In contrast to the consequences under criminal law, the reactions on the part of banks are swift and the consequences are directly noticeable for companies. These generally consist of the threat and subsequent implementation of account freezes, account terminations and the termination of financing agreements. It is therefore important to be prepared and react correctly to corresponding notifications and requests from banks due to the short response times given.

Especially in M&A transactions, it is important to adapt to the changed requirements. Sanctions law issues must be considered throughout almost the entire course of a transaction, both on the acquirer's and the seller's side. To this end, the existing due diligence obligations for the parties involved must be individually determined in advance and suitable risk management methods applied. 

It is therefore important to carry out checks on the target company, the companies and natural persons involved as early as the initial contact or the initiation of talks. The focus here is in particular on clarifying any possible entry of the persons directly involved in the transaction as well as the other persons along the shareholding structures through to the beneficial owners on a relevant sanctions list. 

The extent of the requirements arising from the applicable due diligence obligations must be assessed on the basis of the risk factors to be determined for the specific case. 

The same applies to the evaluation of the results of a sanctions list comparison. If, for example, it turns out that formally there is no exercise of control by persons subject to individual sanctions due to the shareholding ratio under company law (e.g. if the shareholding ratio is below 50%), an examination of the shareholding history may nevertheless reveal indications that suggest a de facto control position of the sanctioned person. This would be the case, for example, if a transfer of shares to persons who are economically or personally dependent on the sanctioned person took place in connection with the inclusion in a sanctions list. If there are corresponding indications, further checks must be carried out, for example of articles of association, partnership agreements, voting agreements, trust agreements, etc.

Possible topics and subjects of sanctions audits in connection with transactions can be listed as follows: