Managing FI Risk in an Era of Increased Enforcement: Part I

In response to tense geopolitical developments, more and more countries have introduced or expanded existing FI rules in recent years (most recently Sweden, with the regimes in Belgium and Ireland expected to come into force in the summer). Sanctions for breaching FI rules can be severe (including rendering the deal void, fines, unwinding orders, and criminal sanctions). Added to this, reviews by FI regulators can be lengthy, involve onerous information-gathering, and (where necessary to resolve concerns) impose remedies on the parties as a condition for clearance. 

This clearly means that FI issues must be considered at an early stage in the due diligence process. In addition, the timeline, process, and conditions for fulfilling the requirements under FI rules need to be reflected in the transaction documents.

Driven by the common desire to minimise adverse deal timings and execution implications, parties are often aligned in quantifying and allocating their respective risks and responsibilities to achieve the relevant FI clearances. However, that balance may shift to the investor (who typically has the filing obligation) or the target, depending on the balance of power between the parties during negotiations. 

A range of FI-related clauses can be incorporated into the transaction agreements to help buyers and sellers successfully manage the FI risks. In Part I of this post, we look at the conditions precedent that should be considered, and how they can be structured to provide not only legal protection, but also commercial comfort, to the parties.

Conditionality: key points to bear in mind

When negotiating the extent and scope of FI conditions, the following need to be considered:

• Nature of FI filings: voluntary filings may be worth the time!

In most jurisdictions operating FI regimes, filings are mandatory and suspensory. And a few countries leave it entirely to the parties to decide whether to notify.

Mandatory and suspensory FI filings must be added as conditions precedent in the transaction documents (even in the absence of substantive national security or public interest concerns), so that the parties will be prevented from closing the transaction before notifying the relevant authority and receiving FI clearance. 

When notification is voluntary, the inclusion of a closing condition is not strictly necessary. Yet this can be subject to negotiation between the parties. On the one hand, the buyer may wish to submit a voluntary filing to remove the risk of FI intervention post-closing, whereas it is likely that the seller will prefer to limit any hurdles to closing, as well as avoid the delay and costs caused by additional filings. 

That said, given the aggressive pursuit of non-notified deals by FI authorities and the greater level of transparency among regulators facilitated by rules like the EU Screening Regulation (if there is a filing in another EU Member State), it is increasingly difficult for transactions to ‘fly under the radar’, and the corresponding risk of the transaction being ‘called-in’ by the relevant authority can be material. Therefore, if the transaction has the potential to raise concerns or trigger questions from a public policy perspective, making it conditional on obtaining voluntary FI clearance may be the safest and recommended route. In addition, this may enable the parties to build a rapport with the authority and manage the timeline and advocacy more effectively.

In some cases, we have also seen a ‘hybrid approach’, meaning that, for a voluntary and non-suspensory filing, the buyer and seller have agreed to make e.g. a Phase I process (usually around two months) a condition for deal closing but not a Phase II process - for which the risk then falls entirely on the buyer. For the buyer, this means that if the transaction is dragged into an (unexpected) in-depth investigation, the entire risk, including any concessions which may have to be given to obtain clearance, falls on them. For the seller, this means that the risk of delay is limited to a clearly predictable timeframe.

• Unclear FI rules: to file or not to file?

FI rules are often broadly drafted, which gives regulators a great degree of discretion to ‘cherry-pick’ transactions of interest. For instance, many jurisdictions do not define key concepts such as ‘national security’ or have open-ended provisions that are not clearly defined in law or practice.

This often results in a degree of uncertainty as to whether a transaction is actually captured by the relevant FI rules. In such ambiguous circumstances, parties may push for diverging risk strategies depending on their commercial position. We often see buyers opting to protect themselves by submitting FI filings on a precautionary basis, whereas sellers will typically prefer for there to be minimal conditions and maximum deal certainty. 

To strike a trade-off, it will be critical for parties to consider whether their transaction triggers other mandatory FI or merger control filings. The reality is that FI authorities are routinely coordinating FI reviews with their counterparts in other jurisdictions, and sometimes even with merger control regulators. As such, submitting a filing may prompt questions from more than one FI or merger control authority which – if concerned that the transaction may raise adverse effects in their jurisdiction – could exercise its power to ‘call-in’ the unnotified transaction. Consequently, the knock-on effects of parallel FI or merger control filings should be strategically considered in the 'risk equation' of whether (or not) to proceed with precautionary filings.

Further, we have seen a number of instances in which FI regulators have reached out to the parties immediately after a deal has become public to establish whether or not a filing should be made. The tricky element of this kind of outreach is that in some jurisdictions the review period begins to run when the regulator gains knowledge that a deal has been agreed. If the parties are not prepared and only start drafting their filing at that point in time, the risk of being dragged into a (technical) Phase II investigation, potentially resulting in delays to the overall deal timetable, increases.

• Upcoming FI regimes: don’t lose sight of the future 

Around the world, new national FI regimes are emerging all the time, and existing regimes are expanding their scope to capture a wider range of transaction types and targets. As a result, it is possible for a transaction to become reportable under new or expanded FI rules in certain jurisdictions, following the signing of the transaction. 

Against this background, a catch-all condition can be an appropriate measure to protect buyers against new mandatory FI rules introduced between signing and closing. However, buyer-driven attempts for increased security are frequently resisted by sellers due to the inherent breadth and uncertainty of catch-all provisions that can complicate the route to closing. To reach a middle ground, parties may choose to reduce the scope of the condition in the transaction documents so that it only covers a limited number of specified national FI regimes which are expected, with high likelihood, to enter into force shortly after signing.

What does this mean for the transacting parties?

As FI screening is set to remain a common feature of dealmaking, anticipating and managing FI risk - along with other customary investment hurdles such as merger control and regulatory approvals - will be essential for a smooth closing. 

In Part II of this post, we will outline additional provisions that parties should consider in relation to FI screening, including long stop dates and ‘hell or high water’ clauses.

Watch this space!