The key issues PE deal teams are facing amidst rapidly changing global sanctions and guidance.
Russia’s recent invasion of Ukraine has created new headwinds for PE firms, as a matrix of sanctions and export controls pose legal challenges for portfolio companies and transaction targets. With sanctions regimes getting ever more complex and such complexity unlikely to reduce any time soon, deal planning and execution requires expert legal counsel and skilful navigation.
1. Buying in – Can I acquire a group that has a presence in Russia?
The legal issues applicable to each deal derive from the intricate interaction of applicable laws and regulations — identifying what sanctions apply to each transaction is an essential but frequently complex first step.
In addition to having to navigate restrictions created by US, UK, EU, and other sanctions, recent transactions have demonstrated that the US ban on new investments in Russia is a central issue for dealmakers. Given the wide reach of the ban, assessing the scope and nature of target group operations is critical to ensure compliance. For example, if a target group is based in Russia or derives a predominant share of its revenue from Russia, US persons are generally prohibited from engaging in a new investment involving that target group — including by financing, approving, or facilitating the investment.
While UK and EU sanctions do not currently incorporate a full investment ban (such a ban has been announced in the UK — although implementation timing is unclear — and currently exists in the EU for energy sector investments), acquirers must comply with a range of measures, including UK sanctions prohibiting certain dealings with “persons connected with Russia”.
2. Selling out – What legal issues am I likely to face if I sell an investment in Russia?
A key difficulty in exiting Russia or selling a stake in a Russian business is determining who to sell to — recent deals indicate that any buyer likely will be Russian, may be subject to sanctions, or otherwise involved in dealings with sanctioned persons. Associated elements of a sale, such as structured payments, related agreements, and royalty payments, may fall within the scope of sanctions, including the US new investment ban. Russian countersanctions are also proving challenging in practice. Sales of operations in Russia can also raise complicated questions under US, EU, or UK export controls relating to the transfer in-country to a new end-user of hardware, software, or technology.
3. Portfolio trading – Can my portfolio companies still trade with Russia?
While no comprehensive ban on trade with Russia exists, PE firms must ensure that business with parties in Russia is consistent with sanctions — certain types of exports to Russia (or imports from Russia) are prohibited. Screening counterparties in Russia, their ultimate beneficial owners, and their financial institutions against the various US, EU, UK and other sanctions lists is important. Many of Russia’s largest banks are subject to sanctions, making receiving money from Russia, or sending money to Russia, impossible in many cases. Western financial institutions may also be hesitant to support lawful transactions with Russia.
4. Parent liability – If I have a portfolio company incorporated in a country that has not imposed sanctions on Russia, could I (the parent) be liable for its actions?
Sanctions apply primarily to persons and companies operating or resident in the relevant territories, covering acts taking place in those territories (or with persons from those territories). UK-based companies, for example, need to ensure they are not actively involved in the acts of their foreign subsidiary, if that foreign subsidiary is engaged in activity that could constitute a sanctions breach if the act were carried out by a UK person.
Firms must accordingly consider portfolio company and subsidiary governance structures. OFSI, the UK sanctions regulator, has indicated that conduct by non-UK subsidiaries might fall within the scope of UK sanctions, depending on the governance structure used. Although US sanctions relating to Russia do not generally apply to foreign subsidiaries that engage in activities with no US jurisdictional touchpoints (e.g., no US banks involved in the transaction), a US parent (or individual US persons) cannot, for example, facilitate or approve sanctioned activities taken by non-US portfolio companies.
5. Directors – Are US, EU, or UK persons at risk if they are directors of a portfolio company trading with Russia?
Yes, if they are involved in approving, facilitating, or participating in activities prohibited under the sanctions regime applicable to them. Consequently, companies should consider the value of implementing a recusal programme.
Depending on jurisdiction, breaching sanctions may be a criminal offence, and individuals responsible for breaches could be imprisoned. In the UK, OFSI implemented a strict liability regime for monetary penalties and now has the power to name and shame sanctions violators, leaving directors exposed to significant reputational damage and fines.
6. Where next?
Governments and regulators are regularly expanding the reach of sanctions and releasing new guidance, including on powers to police breaches. An action that was permissible at the point of initial deal inception may be prohibited by the time of deal execution, so deal teams must remain alert to the rapid pace of change.