Sniffing Out the Sins of the Past
Successor liability is when an acquiring company “inherits” the past illegal acts of a company it has acquired IF it fails to identify and report them as it goes through the processes of merger and acquisition due diligence and merger integration. Sellers often put their best foot forward when courting suitors. The amount of information exchanged is limited making the identification of pre-existing problems such as bribery of foreign officials, money laundering, kickback schemes and other crimes difficult to detect when performing due diligence.
After the deal is agreed to but before the transaction closes, buyers often make supplemental data and documentation requests and require the seller to make certain changes including exiting relationships, divesting parts of the business and remediation of controls and compliance frameworks. These changes are voluntary and are often a part of the purchase negotiation. They also don’t always happen and even if they do, the requests are based upon the limited information and inferences drawn during acquisition due diligence.
Eventually, the deal closes and whatever hidden surprises that had yet to reveal themselves are on the clock. What this means is that an acquiring entity has a limited amount of time to integrate the acquisition into their compliance program and internal controls. So, in addition to the inherent challenges of stitching together email systems, computer networks, enterprise resource planning (ERP) systems, vendors, suppliers, leadership teams, sales forces , management team and core operations, there is time pressure to identify and root out all manner of preexisting bribery, money laundering, sanctions evasion, kickback and embezzlement schemes within the Government’s obliquely worded “reasonable period of time”. Failing to do so can result in some severe consequences. Not only will the organization be criminally and civilly liable for the illegal acts that continued after the deal closed, successor liability enables the government to hold the acquiring company legally responsible for illegal acts that occurred months and sometimes years before the transaction took place.
Does this mean that your organization should stop pursuing inorganic growth through acquisitions? Of course not. It is however a concept that needs to be drilled into the heads of the deal team at every stage of the transaction. Investment bankers and corporate development officers often perform SWOT analyses in evaluating the Strengths, Weaknesses, Opportunities and Threats of a transaction. However, the very tangible and consequential threats of foreign bribery, money laundering, sanctions and trade violations, fraud and financial crime are seldom top of mind. Savvy buyers and their advisors imbed forensic accountants and compliance domain experts within their deal teams who perform activities such as risk assessments, background investigations of key relationships and the sellers themselves and forensic data analytics seeking to identify actual illegal acts and situations in which the control environment and compliance frameworks make the acquisition target unduly susceptible. Done correctly, these subject matter experts will be able to zero in on problematic relationships, revenue that is derived from questionable, less than arm’s length relationships and ongoing schemes and control and compliance weaknesses. Flagging these issues prior to the deal closing provides two very significant benefits. They give the buyer leverage to negotiate a more favorable purchase price by quantifying the costs of remediating the compliance programs and internal controls and possibly the need to disregard any revenue streams of dubious origin when calculating multiples. In some transactions, money is held in escrow to satisfy any potential fines or penalties arising from the wrongdoing that has been identified during due diligence. But most importantly, it will enable the acquiring company to root out the problem before successor liability becomes a problem.