Mergers & Acquisitions in Post Communist Countries


Published on

Find out the opportunities and challenges you may face when making and acquisition in Post Communist Countries.

Published in: Business
1 Like
  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Mergers & Acquisitions in Post Communist Countries

  1. 1. Mergers & Acquisitions in Post-Communist Countries Corporate Legal Strategies for M&A 19-21 May 2010, Asmsterdam Serghei Vahnovan +40 744-667-225 This presentations is intended for educational purposes only and does not replace independent professional advice. Statements of fact and opinions expressed are those of the author and, unless expressly stated to the contrary, are not the opinion or position of the OAO Mechel, its shareholders, affiliates or its management. OAO Mechel does not endorse or approve, and assumes no responsibility for the content, accuracy or completeness of the information presented. The author does not in the ordinary course update, revise or correct any of the information contained in these presentation, or edit or otherwise correct any portion of any presentation, and the information contained in this presentation may no longer be accurate. FULL DISCLAIMER IS LOCATED IN APPENDIX 1
  2. 2. Mechel at a Glance Mechel is a Russian vertically integrated mining, steel, ferroalloys and power group. Shares are listed on New York Stock Exchange, MICEX, RTS; Mechel has a successful track record of acquisitions. Assets located in Russia, USA, Romania, Lithuania, Bulgaria, Kazakhstan. Business strategy envisions additional acquisitions and continued integration; Serghei Vahnovan · May 2010 · page
  3. 3. Investing in Post-Communist Countries: Risks versus Opportunities Serghei Vahnovan · May 2010 · page
  4. 4. Economic Risks <ul><ul><li>High Inflation; </li></ul></ul><ul><ul><ul><li>was experienced by the whole region since the early 1990s, and especially by C.I.S. after the 1998 financial crisis; </li></ul></ul></ul><ul><ul><li>Unstable Currency; </li></ul></ul><ul><ul><ul><li>usually the sales are not in same currency as costs and liabilities; </li></ul></ul></ul><ul><ul><li>Weak Banking System; </li></ul></ul><ul><ul><ul><li>unable, in many cases, to provide adequate liquidity to companies. Significant use of barter transactions and illiquid promissory notes in C.I.S.; </li></ul></ul></ul><ul><ul><li>Loss-Making Enterprises; </li></ul></ul><ul><ul><ul><li>continue to operate due to the lack of effective bankruptcy proceedings or being subsidized by state; </li></ul></ul></ul><ul><ul><li>Possible Solutions : contracts pegged to hard currency, currency hedges, local branches of Western banks, avoid state-run industries; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  5. 5. Political Risks <ul><ul><li>Immature Democracies; </li></ul></ul><ul><ul><ul><li>are inherently unstable, because without real political alternatives, force citizens to seek redress outside the law (orange, rose and tulip revolutions); </li></ul></ul></ul><ul><ul><li>Secessionists Territories; </li></ul></ul><ul><ul><ul><li>are out of control of central government. Companies may and do have assets in Kosovo, Transnistria and Nagorno-Karabakh; </li></ul></ul></ul><ul><ul><li>Terrorist Attacks and Threats; </li></ul></ul><ul><ul><ul><li>may delay transportation and deliveries, increase government regulation, particularly in Russia and Central Asia; </li></ul></ul></ul><ul><ul><li>High Levels of Corruption and Organized Crime; </li></ul></ul><ul><ul><ul><li>including bribery of officials for selective investigations and prosecutions; </li></ul></ul></ul><ul><ul><li>“ Reform-Fatigues” in some countries; </li></ul></ul><ul><ul><li>Possible Solutions: Political Risk Insurance by O.P.I.C. , M.I.G.A. , your export-credit agency or bank, C.D.S., or make your own research ( U.S. Department of State ). Risk lower in E.U. members; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  6. 6. Social Risks <ul><ul><li>Official Data Sources; </li></ul></ul><ul><ul><ul><li>were a “ political issue ”, so may be not accurate, late, substantially less complete or produced on different bases than those used in Western countries; </li></ul></ul></ul><ul><ul><li>Widespread Tax Evasion; </li></ul></ul><ul><ul><ul><li>puts a competitive disadvantage on fully complying companies; </li></ul></ul></ul><ul><ul><li>Shortage of Labor Force; </li></ul></ul><ul><ul><ul><li>due to a decline of working population, and emigration. </li></ul></ul></ul><ul><ul><ul><li>few countries have put in place some real immigration policies; </li></ul></ul></ul><ul><ul><li>Aging Infrastructure; </li></ul></ul><ul><ul><ul><li>needs significant improvement and investment. Particularly affected - rail and road networks, power systems, communication systems; </li></ul></ul></ul><ul><ul><li>Possible Solutions: double check data, prepare a personnel retention policy, rely on your own infrastructure; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  7. 7. Economic Opportunities; <ul><ul><li>Economic Growth; </li></ul></ul><ul><ul><ul><li>still high, by standards of developed countries. </li></ul></ul></ul><ul><ul><ul><li>Poland is the only country in E.U. to avoid recession in present crisis; </li></ul></ul></ul><ul><ul><li>Skilled Labor Force </li></ul></ul><ul><ul><ul><li>especially in technical areas; </li></ul></ul></ul><ul><ul><li>Low Wages; </li></ul></ul><ul><ul><li>Low Taxation; </li></ul></ul><ul><ul><ul><li>vastly adopting flat rate taxation; </li></ul></ul></ul><ul><ul><li>Low Competition; </li></ul></ul><ul><ul><ul><li>in many areas, still undeveloped, leaving place to grow; </li></ul></ul></ul><ul><ul><li>Distressed Assets Sales; </li></ul></ul><ul><ul><ul><li>in order to satisfy the margin calls in current crisis, may provide price opportunities; </li></ul></ul></ul><ul><ul><li>Benefits from Western Know-How; </li></ul></ul><ul><ul><ul><li>still brings spectacular results, especially in C.I.S.; </li></ul></ul></ul>Serghei Vahnovan · May 2010 · page
  8. 8. Available Incentives; <ul><ul><li>Subsidies, tax breaks, preferentially priced land, special infrastructure; </li></ul></ul><ul><ul><li>Non-financial assistance and advantages. </li></ul></ul><ul><ul><ul><li>F.D.I. often given preferential treatment; </li></ul></ul></ul><ul><ul><li>E.U. Law prohibits granting any kind of incentives: </li></ul></ul><ul><ul><ul><li>capable of distorting competition; or </li></ul></ul></ul><ul><ul><ul><li>affecting trade between Member States; </li></ul></ul></ul><ul><ul><li>Main exemptions under E.U. Law: </li></ul></ul><ul><ul><ul><li>areas with abnormally low standard of living or with serious unemployment; </li></ul></ul></ul><ul><ul><ul><li>small and medium enterprises; </li></ul></ul></ul><ul><ul><ul><li>training aid; </li></ul></ul></ul><ul><ul><li>Numerous cases of returned state aid; </li></ul></ul><ul><ul><ul><li>under the scrutiny of local competition authorities or European Commission; ; </li></ul></ul></ul><ul><ul><li>In C.I.S. countries - state aid - adhoc , and individual. </li></ul></ul><ul><ul><li>Possible Solutions: negotiate with multiple countries, obtain a clearance from E.U., structural and cohesion funds; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  9. 9. Legal System: Weakness and Uncertainties Serghei Vahnovan · May 2010 · page
  10. 10. Constantly Changing Legal Framework <ul><ul><li>In planned economies regulation acted as a “ guide ” and “ plan ”; </li></ul></ul><ul><ul><ul><li>as a result, regulation is changing in response to dynamic economic and social conditions; </li></ul></ul></ul><ul><ul><li>Desire to help and plan; </li></ul></ul><ul><ul><ul><li>many societies remain paternal, and some even dictatorial; </li></ul></ul></ul><ul><ul><li>Adapting to western standards; </li></ul></ul><ul><ul><ul><li>may be a difficult process, of repeated trials and errors; </li></ul></ul></ul><ul><ul><li>Low level of respect of private property; </li></ul></ul><ul><ul><ul><li>changes in laws, may used as a latent expropriation threat and even for racketeering purposes ; </li></ul></ul></ul><ul><ul><li>Political immaturity; </li></ul></ul><ul><ul><ul><li>some societies didn’t made a definitive choice of values, so the regulatory framework is changing with electoral cycles; </li></ul></ul></ul><ul><ul><li>Possible Solutions: cover yourself with papers, ask for “ guidance ”, in E.U. members – rely on principles outlined in Directives; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  11. 11. Abundance of Secondary Norms <ul><ul><li>In planned economies regulation had to be “ explained ”; </li></ul></ul><ul><ul><ul><li>executive branch planned the economy; </li></ul></ul></ul><ul><ul><ul><li>entities and citizens feared wrongdoing in a totalitarian society; </li></ul></ul></ul><ul><ul><ul><li>citizens rarely addressed to courts, so there was no judicial interpretation of legal norms and administrative bodies gave the only “ official interpretation ”; </li></ul></ul></ul><ul><ul><ul><li>even when addressed, courts mostly favored state bodies; </li></ul></ul></ul><ul><ul><li>Low quality of regulation and blank areas; </li></ul></ul><ul><ul><ul><li>may force administrative authorities in “ lawmaking ” in face of day to day problems. In new areas, it’s possible that even regulators may not fully understand the law; </li></ul></ul></ul><ul><ul><li>Poorly trained judicial system; </li></ul></ul><ul><ul><ul><li>may favor interpretation from “ professional authorities ” in areas with high level of sophistication, such as taxes, competition, securities, and telecom; </li></ul></ul></ul><ul><ul><li>Judicial precedents; </li></ul></ul><ul><ul><ul><li>generally, have no binding effect; </li></ul></ul></ul><ul><ul><li>Possible Solutions: pay very high attention to secondary norms, often these are applied. Obtain written “ explanations ” in vital areas; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  12. 12. Judicial System <ul><ul><li>A lack of judicial independence; </li></ul></ul><ul><ul><ul><li>even if courts are declared independent, in reality, they may be not; </li></ul></ul></ul><ul><ul><ul><li>judiciary functions may be subject to terms, revocation, retrogradation or suspension by executive power; </li></ul></ul></ul><ul><ul><ul><li>judges may be financially dependent on executive branch or even local authorities; </li></ul></ul></ul><ul><ul><ul><li>in some countries, pressure from political, social and commercial forces; </li></ul></ul></ul><ul><ul><li>Relative inexperience of Courts; </li></ul></ul><ul><ul><ul><li>in new or very specific areas, such as taxation, competition, securities and telecommunications; </li></ul></ul></ul><ul><ul><li>Bankruptcy procedures; </li></ul></ul><ul><ul><ul><li>are not well developed and are subject to abuse </li></ul></ul></ul><ul><ul><li>The system may be slow; </li></ul></ul><ul><ul><ul><li>cases may last a lot longer, then previously envisaged; </li></ul></ul></ul><ul><ul><li>Possible Solutions: whenever possible, choose arbitration. Note that in some countries “ arbitrazh ” may mean a public court, but with commercial competences. Maintain a bulletproof balance sheet; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  13. 13. Legal Enforcement <ul><ul><li>Regulation may be subject to selective enforcement; </li></ul></ul><ul><ul><ul><li>leading to a competitive disadvantage for complying companies; </li></ul></ul></ul><ul><ul><ul><li>a right that's selectively enforced, is not a right; </li></ul></ul></ul><ul><ul><li>Even with judicial decision in hand, it may be difficult to enforce; </li></ul></ul><ul><ul><ul><li>lack of specific regulation, permits often hiding of assets; </li></ul></ul></ul><ul><ul><ul><li>specific, derogatory norms, for enforcing decisions against public bodies, may make it very hard, if not impossible; </li></ul></ul></ul><ul><ul><ul><li>Bailiffs , often fear enforcing a decision taken against state bodies or local potent persons; </li></ul></ul></ul><ul><ul><li>Foreign courts’ judgments and arbitral awards; </li></ul></ul><ul><ul><ul><li>may be difficult to recognize and enforce, on technical grounds; </li></ul></ul></ul><ul><ul><li>In some countries, official and unofficial political resistance; </li></ul></ul><ul><ul><ul><li>to the enforcement of awards against local companies in favor of foreign investors; </li></ul></ul></ul><ul><ul><li>Possible Solutions: get money in advance, insure credit risks, check the treaties, pay close attention to case-law; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  14. 14. Due Diligence: Local Flavors Serghei Vahnovan · May 2010 · page
  15. 15. Shareholder’s Identity <ul><ul><li>Often concealed, through nominees or shell companies. </li></ul></ul><ul><ul><ul><li>always check for ultimate beneficial owner, some have “ colorful ” past; </li></ul></ul></ul><ul><ul><li>Obvious need for protection; </li></ul></ul><ul><ul><ul><li>from tax investigations (“ Yukos affair ”); </li></ul></ul></ul><ul><ul><ul><li>ownership and personal security considerations; </li></ul></ul></ul><ul><ul><li>Beneficial Ownership disclosure; </li></ul></ul><ul><ul><ul><li>rarely required by law or local exchanges; but </li></ul></ul></ul><ul><ul><ul><li>may have implications regarding related party transactions; </li></ul></ul></ul><ul><ul><li>Investigative powers ; </li></ul></ul><ul><ul><ul><li>rarely prescribed, except anti-monopoly cases; but </li></ul></ul></ul><ul><ul><ul><li>usually, made ineffective, by privacy provisions in offshore jurisdictions; </li></ul></ul></ul><ul><ul><li>Implications to the deal; </li></ul></ul><ul><ul><ul><li>may be subject to regulations in exotic jurisdictions; </li></ul></ul></ul><ul><ul><ul><li>may be difficult to enforce; </li></ul></ul></ul><ul><ul><li>Possible Solutions: obtain voluntary disclosure, legal opinions from all the jurisdictions involved; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  16. 16. Joint Ventures <ul><ul><li>May be mandatory; </li></ul></ul><ul><ul><ul><li>in some countries and/or industries; </li></ul></ul></ul><ul><ul><li>But, controlling a joint venture; </li></ul></ul><ul><ul><ul><li>may be harder than previously envisaged; </li></ul></ul></ul><ul><ul><ul><li>Ron Lauder bought his TV station, twice (CME-Zelezny affair); </li></ul></ul></ul><ul><ul><ul><li>public authorities may be used as tool (TNK-BP affair); </li></ul></ul></ul><ul><ul><li>Legal provisions may be made ineffective; </li></ul></ul><ul><ul><ul><li>by old-established customs; </li></ul></ul></ul><ul><ul><ul><li>charter provisions; </li></ul></ul></ul><ul><ul><ul><li>political and judiciary favoritism; </li></ul></ul></ul><ul><ul><li>Local influential partners; </li></ul></ul><ul><ul><ul><li>are good, if carefully managed; but </li></ul></ul></ul><ul><ul><ul><li>local influential enemies are not; </li></ul></ul></ul><ul><ul><li>Possible Solutions: if possible, avoid joint ventures. Otherwise use charter provisions, make the joint-venture in holding companies; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  17. 17. Titles Clearance <ul><ul><li>Most companies have been privatized; </li></ul></ul><ul><ul><ul><li>in some countries, privatization still regarded as immoral and “ thievery ”, partly because of communist ideas, partly because of corruption that surrounded it; </li></ul></ul></ul><ul><ul><ul><li>legislation is vague, internally inconsistent and in conflict with other elements of legislation, as result of “ moral anguish ” and “ cutting corners ”; </li></ul></ul></ul><ul><ul><ul><li>as a result, many privatizations are arguably deficient and may be subject to challenge, at least on technical grounds, including through selective action; </li></ul></ul></ul><ul><ul><li>Former partners, may be excluded in questionable ways; </li></ul></ul><ul><ul><ul><li>challenges from departing shareholders, even in exotic jurisdictions; </li></ul></ul></ul><ul><ul><li>Assets acquired in bankruptcy procedures, may be challenged; </li></ul></ul><ul><ul><li>Assets may be subject of communist nationalization, in the past; </li></ul></ul><ul><ul><ul><li>privatization of old enterprises, may be subject to challenge from pre-communist era owners and their heirs; </li></ul></ul></ul><ul><ul><ul><li>land and buildings are under disputes, in many countries; </li></ul></ul></ul><ul><ul><ul><li>legislation and case-law remain inconsistent; </li></ul></ul></ul><ul><ul><li>Possible Solutions: extinctive prescription (statute of limitations), settlements with or declarations from former partners and pre-communist owners, check various registers; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  18. 18. Licenses and Permits <ul><ul><li>The planned economy was build on “permits”, not on freedom; </li></ul></ul><ul><ul><ul><li>even the simplest acts or activities may be licensed, or require special permissions; </li></ul></ul></ul><ul><ul><ul><li>discretion in issuing and renewing, because, even if bona fide , some authorities still try to ” plan ”, and decide what’s “ good for society and economy ”; </li></ul></ul></ul><ul><ul><ul><li>the legal framework leaves considerable discretion, because regulators, may believe that “ the state interest shall be protected ” and “ daddy knows best ” ; </li></ul></ul></ul><ul><ul><li>In many countries, state retains the ownership of “ strategic assets ”, such as land, subsoil, radio frequencies, beach and infrastructure. </li></ul></ul><ul><ul><ul><li>as consequence access to these assets, shall be licensed; </li></ul></ul></ul><ul><ul><ul><li>inconsistent and vague legislation, as a result of “ moral anguish ”, may lead to revocation or invalidation; </li></ul></ul></ul><ul><ul><ul><li>considerable discretion in issuing and renewing such licenses, because the state remains “ the owner ”; </li></ul></ul></ul><ul><ul><ul><li>considerable mess in defining “ public ” and “ private ” state property; </li></ul></ul></ul><ul><ul><li>Possible Solutions: written confirmations from regulators that the licenses are in force, ask for guidance in compliance with their terms, start renewing your licenses early, make sure it’s private state property; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  19. 19. Taxation <ul><ul><li>Tax legislation may be subject to; </li></ul></ul><ul><ul><ul><li>frequent change; </li></ul></ul></ul><ul><ul><ul><li>varying interpretation; </li></ul></ul></ul><ul><ul><ul><li>inconsistent enforcement; </li></ul></ul></ul><ul><ul><li>Despite unlawfulness, tax authorities may; </li></ul></ul><ul><ul><ul><li>apply taxes retrospectively, by reinterpretation; </li></ul></ul></ul><ul><ul><ul><li>issue tax claims for periods which, under the statute of limitations, have expired; and </li></ul></ul></ul><ul><ul><ul><li>review the same tax periods on multiple occasions; </li></ul></ul></ul><ul><ul><li>Differing legal interpretation exist; </li></ul></ul><ul><ul><ul><li>between companies subject to such taxes and the Government; </li></ul></ul></ul><ul><ul><ul><li>within Government ministries and organizations; </li></ul></ul></ul><ul><ul><li>Large discretionary power in; </li></ul></ul><ul><ul><ul><li>deductibility of certain expenses; </li></ul></ul></ul><ul><ul><ul><li>transfer pricing; </li></ul></ul></ul><ul><ul><li>Possible Solutions: ask for tax audit, cover yourself with papers, ask for “ guidance ”, delay partially the payment until first tax audit; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  20. 20. Taxation - continued <ul><ul><li>“ Tax-optimization ” is wide-spread; </li></ul></ul><ul><ul><li>Effective tax rate, may be higher than declared; </li></ul></ul><ul><ul><ul><li>due to severe limitation in deductibility of certain expenses and non-deductibility of others; </li></ul></ul></ul><ul><ul><ul><li>non-consolidation of financial situations; </li></ul></ul></ul><ul><ul><li>Jurisprudential undefined notions, unfavorable to taxpayers ; </li></ul></ul><ul><ul><ul><li>tax liabilities to be extended beyond the three-year term, if tax payer has “ obstructed ” or “ hindered ” a tax inspection (Russian Constitutional Court) </li></ul></ul></ul><ul><ul><ul><li>“ taxpayer acting in bad faith ” and ‘‘ bona fide taxpayer ” (Russian Constitutional Court) </li></ul></ul></ul><ul><ul><ul><li>“ unjustified tax benefit ” and “ substance over form ” approach (Plenum of the Arbitrazh); </li></ul></ul></ul><ul><ul><li>Tax audits; </li></ul></ul><ul><ul><ul><li>may last longer than envisaged; </li></ul></ul></ul><ul><ul><ul><li>do not exclude the possibility of subsequent claims relating to the audited period; </li></ul></ul></ul><ul><ul><li>Recoverability of V.A.T. and other taxes from budget; </li></ul></ul><ul><ul><ul><li>may be burdensome, and delayed indefinitely on technicalities; </li></ul></ul></ul><ul><ul><li>International taxation treaties, may be difficult to apply; </li></ul></ul><ul><ul><li>Possible Solutions: watch case-law, ask for “ guidance ”; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  21. 21. Weak Accounting and Internal Control <ul><ul><li>Accounting and financial reporting; </li></ul></ul><ul><ul><ul><li>may be less developed; and </li></ul></ul></ul><ul><ul><ul><li>may not provide management with accurate information; </li></ul></ul></ul><ul><ul><ul><li>may have no integrated information systems; </li></ul></ul></ul><ul><ul><li>Internal Control; </li></ul></ul><ul><ul><ul><li>may be less developed; and </li></ul></ul></ul><ul><ul><ul><li>may not spot the problems at the early stages; </li></ul></ul></ul><ul><ul><li>International Financial Reporting Statements; </li></ul></ul><ul><ul><ul><li>may not exist; or </li></ul></ul></ul><ul><ul><ul><li>even if declared as implemented, may be deficient ; </li></ul></ul></ul><ul><ul><ul><li>often prepared in local standards, and transformed in IFRS through various adjustments, and consolidations; </li></ul></ul></ul><ul><ul><ul><li>may depend on key staff; </li></ul></ul></ul><ul><ul><li>Possible Solutions: double check data, retain key personnel, consider expatriates; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  22. 22. Key Personnel <ul><ul><li>Ability to compete and even survive, can depend on key personnel; </li></ul></ul><ul><ul><ul><li>real payments may be not fully “accounted”; </li></ul></ul></ul><ul><ul><ul><li>some employees may appear as self-employed, for tax reasons; </li></ul></ul></ul><ul><ul><ul><li>connections are very important, especially on local level ; </li></ul></ul></ul><ul><ul><ul><li>“ rainmakers ” remain essential; </li></ul></ul></ul><ul><ul><ul><li>director & officers liability, life insurance may be missing; </li></ul></ul></ul><ul><ul><li>Competition for personnel in some areas, very intense; </li></ul></ul><ul><ul><ul><li>partly due to small number of qualified individuals; </li></ul></ul></ul><ul><ul><ul><li>partly due to lack of experience in market economy; </li></ul></ul></ul><ul><ul><ul><li>partly due to overemphasize of communist education in technical areas; </li></ul></ul></ul><ul><ul><li>Personal attachment to departing shareholder; </li></ul></ul><ul><ul><li>Enforcement of non-competing agreements may be problematic; </li></ul></ul><ul><ul><li>Possible Solutions: make sure the real payment is fully accounted , non-competing agreements with departing shareholder, retain them as consultants, consider expatriates, always retain “ rainmakers ”; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  23. 23. Operations <ul><ul><li>Currency risk - very important; </li></ul></ul><ul><ul><ul><li>exporters have the costs in local currencies.; </li></ul></ul></ul><ul><ul><ul><li>often, liabilities in hard currency due to high interest in local currencies and weak banking system; </li></ul></ul></ul><ul><ul><li>Insurance; </li></ul></ul><ul><ul><ul><li>insurance industry may be not very well developed; </li></ul></ul></ul><ul><ul><ul><li>companies may lack coverage of normal risks; and </li></ul></ul></ul><ul><ul><ul><li>even mandatory insurance, may be missing; </li></ul></ul></ul><ul><ul><ul><li>risk of non-payment of insured claims; </li></ul></ul></ul><ul><ul><li>Connections; </li></ul></ul><ul><ul><ul><li>often, more important than contracts; </li></ul></ul></ul><ul><ul><li>Check the authenticity of presented documents, with state bodies; </li></ul></ul><ul><ul><li>Possible Solutions: check the reserves for currency risks, double check insurance, make sure the material contracts will continue; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  24. 24. Trade Barriers <ul><ul><li>E.U. Law prohibits any kind of barriers between states; </li></ul></ul><ul><ul><li>Candidates countries, have special arrangements with E.U.; </li></ul></ul><ul><ul><ul><li>check if your industry is covered by them; </li></ul></ul></ul><ul><ul><li>Non E.U. companies may face protective tariffs, duties and quotas </li></ul></ul><ul><ul><ul><li>that reduce their competitiveness in, and limit its access to E.U.; </li></ul></ul></ul><ul><ul><ul><li>may face trade barriers from other markets, lacking the E.U. negotiation force; </li></ul></ul></ul><ul><ul><ul><li>may face new trade barriers, in the future; </li></ul></ul></ul><ul><ul><li>Non E.U. companies may benefit from trade barriers; </li></ul></ul><ul><ul><ul><li>discount them in your financial analysis; </li></ul></ul></ul><ul><ul><ul><li>check if the company may survive future competition, without them; </li></ul></ul></ul><ul><ul><li>Possible Solutions: E.U. members or candidates, semi-finished products that historically never faced protective measures, prepare early for future competition; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  25. 25. Publicly Provided Services <ul><ul><li>In many countries, the state retains ownership of “ strategic services ”; </li></ul></ul><ul><ul><ul><li>energy (electricity and natural gas); </li></ul></ul></ul><ul><ul><ul><li>transportation and ports; </li></ul></ul></ul><ul><ul><ul><li>telecommunications; </li></ul></ul></ul><ul><ul><ul><li>waste and water services; </li></ul></ul></ul><ul><ul><li>May be unreliable; </li></ul></ul><ul><ul><ul><li>often irresponsible and slow, but in many cases the only alternative; </li></ul></ul></ul><ul><ul><li>Prices can increase in future; </li></ul></ul><ul><ul><ul><li>often controlled by government, and used as a subvention tool, but such a model eroding as a result of globalization; </li></ul></ul></ul><ul><ul><li>In many countries, at different stages of liberalizations; </li></ul></ul><ul><ul><li>Possible Solutions: when possible, rely on your own services, check the government action plans, discount tariff increases to market rates; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  26. 26. Compliance <ul><ul><li>Health, safety and environmental standards; </li></ul></ul><ul><ul><ul><li>are likely to become more stringent; and </li></ul></ul></ul><ul><ul><ul><li>the enforcement of the existing one – more vigorous; </li></ul></ul></ul><ul><ul><ul><li>clean-up costs may be huge; </li></ul></ul></ul><ul><ul><li>Reporting standards for listed securities; </li></ul></ul><ul><ul><ul><li>are likely to be weak, but in future may become more stringent </li></ul></ul></ul><ul><ul><ul><li>the enforcement of existing standards may increase; </li></ul></ul></ul><ul><ul><li>Intellectual Property; </li></ul></ul><ul><ul><ul><li>still an issue, in many countries; </li></ul></ul></ul><ul><ul><ul><li>software piracy; </li></ul></ul></ul><ul><ul><ul><li>trademarks; </li></ul></ul></ul><ul><ul><ul><li>patents; </li></ul></ul></ul><ul><ul><ul><li>employee inventions; </li></ul></ul></ul><ul><ul><li>Possible Solutions: assume E.U. norms, check the reserves for environmental liabilities, plans for reductions of pollution, implement disclosure standards, double check IP; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  27. 27. Social Issues <ul><ul><li>Political and social considerations; </li></ul></ul><ul><ul><ul><li>may prevent from doing what’s permitted legally; </li></ul></ul></ul><ul><ul><li>Mono-industrial towns, with one significant employer; </li></ul></ul><ul><ul><ul><li>may prevent making planned reductions in numbers of employees; </li></ul></ul></ul><ul><ul><li>Mono-industrial towns, with one significant taxpayer; </li></ul></ul><ul><ul><ul><li>may impose a “ de facto ” tax burden, that is beyond of official one; </li></ul></ul></ul><ul><ul><ul><li>communities may rely on the company, to maintain its current commitments in respect to social, employment and welfare programs; </li></ul></ul></ul><ul><ul><li>Inheritance of social infrastructure; </li></ul></ul><ul><ul><ul><li>such as kinder gardens, professional schools, sport clubs and medical clinics; </li></ul></ul></ul><ul><ul><ul><li>may put you in a position to provide free social services, not only to your employees, but to the whole town or region; </li></ul></ul></ul><ul><ul><li>Possible Solutions: whenever possible, transfer them to local authorities, even for free. Otherwise, discount these expenses as taxes; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  28. 28. Enforcement of securities and pledges. <ul><ul><li>Enforcement of securities and pledges; </li></ul></ul><ul><ul><ul><li>generally requires a court order; and </li></ul></ul></ul><ul><ul><ul><li>a public sale of the relevant collateral; </li></ul></ul></ul><ul><ul><li>Courts may delay such proceedings; </li></ul></ul><ul><ul><ul><li>at their discretion, for a period of up to one year upon a pledgor’s application.; </li></ul></ul></ul><ul><ul><li>State registration; </li></ul></ul><ul><ul><ul><li>is generally required, for such pledges, to be valid and/or opposable ; </li></ul></ul></ul><ul><ul><li>Often, no pledge registration system; </li></ul></ul><ul><ul><ul><li>for collateral, other than mortgages; </li></ul></ul></ul><ul><ul><ul><li>may contribute to the incidence of unexpected and/or conflicting claims of secured creditors to the pledged property. </li></ul></ul></ul><ul><ul><li>Enforcement may be made ineffective; </li></ul></ul><ul><ul><ul><li>by institution of “ propiska ”, a registration system for housing occupants ; </li></ul></ul></ul><ul><ul><li>Possible Solutions: discount collateral heavily, retain non-registrable pledge in hand, or at least original documents; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  29. 29. Material Litigation <ul><ul><li>Privatization Challenges; </li></ul></ul><ul><ul><li>Litigation against main shareholder; </li></ul></ul><ul><ul><ul><li>even in exotic jurisdictions; </li></ul></ul></ul><ul><ul><li>Claims from former shareholders; </li></ul></ul><ul><ul><ul><li>even from pre-communist era; </li></ul></ul></ul><ul><ul><li>Claims from former owners of assets; </li></ul></ul><ul><ul><ul><li>even from pre-communist era; </li></ul></ul></ul><ul><ul><li>Tax claims; </li></ul></ul><ul><ul><li>Governmental authorities; </li></ul></ul><ul><ul><li>Licenses and permits; </li></ul></ul><ul><ul><li>Possible Solutions: check all the jurisdictions involved, settle anything could reasonably settled, delay a part of payments until resolved; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  30. 30. Privatisation: a different type of acquisition Serghei Vahnovan · May 2010 · page
  31. 31. Methods of privatization. <ul><ul><li>Mass privatization - vouchers; </li></ul></ul><ul><ul><ul><li>Direct - when majority of citizens received shares in various companies, without any payment. Didn’t bring new capital or know-how; </li></ul></ul></ul><ul><ul><ul><li>Indirect - through managed investment funds, in which citizens received shares. Often pose corporate governance issues. May present interest, because usually available at discount to their net value; </li></ul></ul></ul><ul><ul><li>M.E.B.O.; </li></ul></ul><ul><ul><ul><li>Management and employees buyout. Often degenerates to just Management Buyout; </li></ul></ul></ul><ul><ul><li>Restitution to former owners; </li></ul></ul><ul><ul><ul><li>Rises a lot of problems in practice, because the assets changed in 50 years; </li></ul></ul></ul><ul><ul><li>Privatization through capital markets; </li></ul></ul><ul><ul><ul><li>controlling block is kept by the state, and a minority stake is listed by IPO; </li></ul></ul></ul><ul><ul><li>Strategic investment; </li></ul></ul><ul><ul><ul><li>When the controlling stake is sold to an investor, deemed as “ strategic ”. </li></ul></ul></ul><ul><ul><li>Possible Solutions: just the last one suitable for M&A. M.E.B.O. may also be regarded as an option, but it’s difficult to held anyone accountable for the liabilities that may arise; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  32. 32. Privatization - an exception to general framework. <ul><ul><li>Privatization – always an exception to private law; </li></ul></ul><ul><ul><ul><li>special laws, often enacted for every single privatization case; </li></ul></ul></ul><ul><ul><ul><li>such special laws, often updated and modified, as a result of “ moral anguish ”; </li></ul></ul></ul><ul><ul><ul><li>a plethora of secondary norms, completing, and sometimes even conflicting with even these special laws; </li></ul></ul></ul><ul><ul><li>A lot of technicalities; </li></ul></ul><ul><ul><ul><li>in order to avoid thievery. Usually leads to even higher corruption; </li></ul></ul></ul><ul><ul><li>Social responsibilities, imposed on the buyer; </li></ul></ul><ul><ul><ul><li>employees and their families, have a right to vote in election; </li></ul></ul></ul><ul><ul><li>Sometimes abnormal expectations; </li></ul></ul><ul><ul><ul><li>some national enterprises may be regarded as “ jewel of the crown ”, even if they may be mediocre on international level; </li></ul></ul></ul><ul><ul><li>Local buyers may be favored; </li></ul></ul><ul><ul><li>Possible Solutions: double check special legislation, hire local counsels, set up a local company; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  33. 33. Specifics <ul><ul><li>Status of personnel: public servants or not? </li></ul></ul><ul><ul><li>Special rights may be assigned to privatization body; </li></ul></ul><ul><ul><ul><li>that exceeds the ones for a normal seller, such as: </li></ul></ul></ul><ul><ul><ul><li>the right of inspection; </li></ul></ul></ul><ul><ul><ul><li>the right of unilateral termination; </li></ul></ul></ul><ul><ul><ul><li>non-accountability for the hidden liabilities; </li></ul></ul></ul><ul><ul><li>Investments are always assumed, and often more important than price; </li></ul></ul><ul><ul><ul><li>but pay close attention to the meaning of term “ investments ”; </li></ul></ul></ul><ul><ul><li>No real difference between public assets and that of the enterprise; </li></ul></ul><ul><ul><ul><li>but after privatization, you may miss such vital assets, or pay for them handsomely; </li></ul></ul></ul><ul><ul><li>The Seller may be the Regulator (ex: some ministry); </li></ul></ul><ul><ul><ul><li>and you may end arguing with your regulator; </li></ul></ul></ul><ul><ul><ul><li>or even suing it; </li></ul></ul></ul><ul><ul><li>Possible Solutions: check special legislation, use local counsels, check the status of vital assets, put in agreement as much as possible; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  34. 34. Business as usual after privatization? <ul><ul><li>Regulation; </li></ul></ul><ul><ul><ul><li>may be enforced fully, even if it had loose application before; </li></ul></ul></ul><ul><ul><ul><li>new regulation, may appear, rarely favorable to the recently privatized enterprise; </li></ul></ul></ul><ul><ul><li>Industry specific taxes and tariffs; </li></ul></ul><ul><ul><ul><li>such as for use of frequencies, subsoil, may be raised; </li></ul></ul></ul><ul><ul><ul><li>new taxes may appear or enforced fully; </li></ul></ul></ul><ul><ul><li>Privatization and regulatory reforms ; </li></ul></ul><ul><ul><ul><li>monopolies are broken-up; </li></ul></ul></ul><ul><ul><ul><li>exclusive state concessions and dominant state demand disappear; </li></ul></ul></ul><ul><ul><ul><li>industry looses it’s privileged status (utilities, telecoms, flag carriers); </li></ul></ul></ul><ul><ul><li>If the industry is tightly regulated and socially sensible; </li></ul></ul><ul><ul><ul><li>such as utilities, it may be difficult to rise the prices; </li></ul></ul></ul><ul><ul><li>Audits, from public authorities; </li></ul></ul><ul><ul><ul><li>may be intensified, finding problems that were never seen before; </li></ul></ul></ul><ul><ul><ul><li>sales to state, the extent of price control, state aid; </li></ul></ul></ul><ul><ul><li>Possible Solutions: contractual provisions, assume nothing ; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  35. 35. Post-Privatization <ul><ul><li>Special provision, usually exists; </li></ul></ul><ul><ul><ul><li>in order to monitor the execution of the privatization contract; </li></ul></ul></ul><ul><ul><li>May be carried out by the selling body; </li></ul></ul><ul><ul><ul><li>that brings a conflict of interests and gives the power for wild interpretations; </li></ul></ul></ul><ul><ul><ul><li>may be carried out by any government authority; </li></ul></ul></ul><ul><ul><li>Usually done on early basis, but may be sudden; </li></ul></ul><ul><ul><li>May impose some restriction on: </li></ul></ul><ul><ul><ul><li>selling assets; </li></ul></ul></ul><ul><ul><ul><li>changing the business; </li></ul></ul></ul><ul><ul><ul><li>laying-off employees; </li></ul></ul></ul><ul><ul><li>Usually finishes with a special closing document; </li></ul></ul><ul><ul><li>Any deviations – sanctioned drastically; Investments obligations; </li></ul></ul><ul><ul><li>Possible Solutions: cover with papers, when in doubt - ask for guidance and permissions, always ask for a closing document; </li></ul></ul>Serghei Vahnovan · May 2010 · page
  36. 36. Drafting and Negotiating the Agreement Serghei Vahnovan · May 2010 · page
  37. 37. Drafting <ul><ul><li>Drafting shall be done by or closely with; </li></ul></ul><ul><ul><ul><li>the team that conducted the due diligence; </li></ul></ul></ul><ul><ul><li>The first draft shall be always proposed by you; </li></ul></ul><ul><ul><ul><li>even if it will be re-negotiated, you are setting up the framework; </li></ul></ul></ul><ul><ul><ul><li>the seller, may be not prepared to draft an agreement of such complexity; or </li></ul></ul></ul><ul><ul><ul><li>may be not even aware of all the risks; </li></ul></ul></ul><ul><ul><li>Put in the draft as much as you can; </li></ul></ul><ul><ul><ul><li>even if it’s merely repeating existing legal norms; </li></ul></ul></ul><ul><ul><li>Because the framework constantly changes; </li></ul></ul><ul><ul><ul><li>such norms may disappear, or be changed ; </li></ul></ul></ul><ul><ul><ul><li>you may provide your own interpretation of contractual provisions, hedging against changes in case-law and/or wild interpretations; </li></ul></ul></ul>Serghei Vahnovan · May 2010 · page
  38. 38. Negotiating = Reducing the Risks. <ul><ul><li>Never merge, always acquire; </li></ul></ul><ul><ul><ul><li>you may be never sure of hidden liabilities, isolate the risk in one business ; </li></ul></ul></ul><ul><ul><ul><li>you may expose you to new jurisdictions; </li></ul></ul></ul><ul><ul><ul><li>even if planned, postpone merger until thing clear out; </li></ul></ul></ul><ul><ul><ul><li>make sure you don’t fall under “de facto merger” case-law or legislation; </li></ul></ul></ul><ul><ul><li>Buy-out minority shareholders, whenever possible. </li></ul></ul><ul><ul><ul><li>the rules protecting minority shareholders are new, and constantly evolving; </li></ul></ul></ul><ul><ul><li>Price‑adjustment mechanisms, are essential; </li></ul></ul><ul><ul><ul><li>in respect to working capital; </li></ul></ul></ul><ul><ul><ul><li>net debt; </li></ul></ul></ul><ul><ul><ul><li>cases reported where the owners have stripped the target company of substantial amounts of money between signing the deal and closing it; </li></ul></ul></ul><ul><ul><li>Delay partially payments, until; </li></ul></ul><ul><ul><ul><li>first official tax audits; </li></ul></ul></ul><ul><ul><ul><li>renewing of essential licenses and permits; </li></ul></ul></ul><ul><ul><ul><li>settlement of material litigation; </li></ul></ul></ul><ul><ul><ul><li>because such risks may be non-assessable; </li></ul></ul></ul>Serghei Vahnovan · May 2010 · page
  39. 39. Negotiating = Reducing the Risks – cont’d. <ul><ul><li>Price adjustment for performance; </li></ul></ul><ul><ul><ul><li>on basis of operational profits, for at least one year; </li></ul></ul></ul><ul><ul><ul><li>but buyer have to conduct business diligently to achieve the earn-out levels; </li></ul></ul></ul><ul><ul><ul><li>set-up a mechanism for handling adjustments, without going to court; </li></ul></ul></ul><ul><ul><li>Payment - use of third-party reliable escrow; </li></ul></ul><ul><ul><ul><li>may save from the need to go court; </li></ul></ul></ul><ul><ul><li>Always insist for covenants to “ facilitate closing ”; </li></ul></ul><ul><ul><ul><li>filing government reports; </li></ul></ul></ul><ul><ul><ul><li>seeking third parties consents; </li></ul></ul></ul><ul><ul><ul><li>obtaining director and shareholder approvals; </li></ul></ul></ul><ul><ul><ul><li>obtaining governmental approvals; </li></ul></ul></ul><ul><ul><ul><li>a blanket provision - “ best efforts to close ”; </li></ul></ul></ul><ul><ul><li>Agree in advance on damages; </li></ul></ul><ul><ul><ul><li>for every contractual provision; </li></ul></ul></ul><ul><ul><ul><li>otherwise meaningful damages will be hard to prove; </li></ul></ul></ul>Serghei Vahnovan · May 2010 · page
  40. 40. Representations and Warranties <ul><ul><li>Based on actual condition, not knowledge; </li></ul></ul><ul><ul><li>Accuracy of financial statements, including their compliance to IFRS; </li></ul></ul><ul><ul><ul><li>Collectibility of accounts receivable. An allowance for bad debts should be included. </li></ul></ul></ul><ul><ul><ul><li>Value and obsolescence of inventory; </li></ul></ul></ul><ul><ul><ul><li>Usability and value of assets, including prepaid items; </li></ul></ul></ul><ul><ul><ul><li>Lack of undisclosed liabilities; </li></ul></ul></ul><ul><ul><li>Tax liabilities, including those arising on the transaction; </li></ul></ul><ul><ul><ul><li>establish a mechanism on how to handle post-closing tax claims; </li></ul></ul></ul><ul><ul><li>Compliance with laws; </li></ul></ul><ul><ul><ul><li>usually a blanket statement that seller is in compliance with all laws; </li></ul></ul></ul><ul><ul><li>Pending and threatened claims; </li></ul></ul><ul><ul><ul><li>usually a blanket statement that seller is in compliance with all laws; </li></ul></ul></ul><ul><ul><li>Past representations in other agreements, declarations; </li></ul></ul><ul><ul><ul><li>check if are included in the main agreement; </li></ul></ul></ul><ul><ul><ul><li>check if are superseded by the main agreement or will survive ; </li></ul></ul></ul>Serghei Vahnovan · May 2010 · page
  41. 41. Contract Law and Court. <ul><ul><li>Always choose a Western Law and Court to govern the agreement; </li></ul></ul><ul><ul><ul><li>the local law may be underdeveloped in M&A; </li></ul></ul></ul><ul><ul><ul><li>subject to changes and wild interpretation; </li></ul></ul></ul><ul><ul><ul><li>local courts may be ineffective and subject to local influences; </li></ul></ul></ul><ul><ul><ul><li>bias for local companies can be strong; </li></ul></ul></ul><ul><ul><li>But take in account that in some area you can’t escape local Law; </li></ul></ul><ul><ul><ul><li>in such areas as Corporate Law and Compliance, Insolvency; </li></ul></ul></ul><ul><ul><ul><li>check the local Conflict Rules, for mandatory provisions (public order); </li></ul></ul></ul><ul><ul><li>Consider setting up a holding company, and buy it; </li></ul></ul><ul><ul><ul><li>in order to escape mandatory local provisions; </li></ul></ul></ul><ul><ul><li>Whenever possible choose arbitration; </li></ul></ul><ul><ul><ul><li>for speed; </li></ul></ul></ul><ul><ul><ul><li>for costs; </li></ul></ul></ul><ul><ul><ul><li>for privacy issues; </li></ul></ul></ul><ul><ul><li>But make sure you will be capable to enforce; </li></ul></ul><ul><ul><ul><li>a particular arbitration award in a particular country; </li></ul></ul></ul>Serghei Vahnovan · May 2010 · page
  42. 42. Thank You! Questions? <ul><ul><li>[email_address] </li></ul></ul>Serghei Vahnovan · May 2010 · page
  43. 43. Appendix 1 Global Disclaimer The information and opinions in this presentation are believed by author to be reliable and have been obtained from public sources believed to be reliable. However, the author makes no representation as to the accuracy or completeness of such information. The author may be have an interest in and open buy or sell proprietary positions in securities mentioned in this presentation. Opinions, estimates and projections in this presentation constitute the current judgment and opinion of the author as of the date of this presentation. They do not necessarily reflect the opinions of OAO Mechel and are subject to change without notice. The author has no obligation to update, modify or amend this presentation or to otherwise notify a reader thereof in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. This presentation is provided for informational purposes only. It is not to be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular investment strategy in any jurisdiction or as an advertisement of any financial instruments. The investments discussed in this presentation may not be suitable for all investors and investors must make their own investment decisions using their own independent advisors as they believe necessary and based upon their specific financial situations and investment objectives. If a investment is denominated in a currency other than an investor’s currency, a change in exchange rates may adversely affect the price or value of, or the income derived from the investment, and such investor effectively assumes currency risk. In addition, income from an investment may fluctuate and the price or value of investments described in this presentation, either directly or indirectly, may rise or fall. Furthermore, past performance is not necessarily indicative of future results. The information contained in this presentation does not constitute the provision of investment advice. The information, interpretation, opinions and advice submitted herein are not in the context of an investment consultancy service. Investment consultancy services are provided by brokerage firms, portfolio management companies and banks that are not authorized to accept deposits through an investment consultancy agreement to be entered into such corporations and their clients. The interpretation and advices herein are submitted on the basis of personal opinion of the relevant interpreters and consultants. Such opinion may not fit your financial situation and your profit/risk preferences. Accordingly, investment decisions solely based on the information herein may not result in expected outcomes. The information, interpretation, opinions and advice submitted herein are not in the context of, and do not constitute, any appraisal or evaluation activity requiring a license in the Russian Federation. This presentation may not be reproduced, distributed or published by any person for any purpose without author's prior written consent. Please cite source when quoting. Copyright © 2010 Serghei Vahnovan May 2010