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Cross-border transactions require cross-border due diligence: This article will provide U.S. practitioners with an awareness — certainly not all-inclusive — of issues in such due diligence. COMPETITION There is a growing tendency of nations to apply their laws to offshore mergers. Acquirers must pay substantial fees to reviewing authorities and for document preparation and filings in multiple jurisdictions. Foreign counterparts must understand the pre-acquisition notification and reporting requirements of the U.S. Hart-Scott-Rodino Antitrust Act (HSR). Special attention should be given to the applicability of HSR in (i) acquisitions by U.S. persons of foreign assets/voting securities of a foreign issuer as well as (ii) acquisitions by foreign persons of voting securities/foreign assets of a foreign target when control of a U.S. target company changes or where large sales revenue derives from the United States. HSR competition filings are similar to filings that are considered to have a “community dimension” under the European Union Merger Regulation. The United States is authorized under the Exon-Florio Amendment to prohibit, suspend or reverse transactions if it determines that an acquisition could threaten U.S. national security. THE ENVIRONMENT Recently, the European Commission adopted a Proposal for a Directive that imposes criminal sanctions for breaches of environmental law at the EU level. Cross-border transportation of waste is regulated by the Basel Convention. There are international “extended producer responsibility” initiatives in areas such as electronic equipment and components. The EU has a draft directive on waste disposal of electronic equipment, proposing a year 2004 ban on lead, mercury and cadmium, recycling requirements and required marking symbols. The abandonment by the U.S. of the Kyoto Protocol does not mean that U.S. companies are released from observing the Protocol in their European operations. Brokers in the U.S. and the U.K. can customize insurance coverage, such as: � secured lender liability: designed to protect loans secured by real property from environmental tort claims and mandated clean-up. � asbestos abatement liability: designed to cover claims for bodily injury and property damage resulting from asbestos abatement operations. � cleanup cost cap: designed to facilitate remediation by paying for financial losses which exceed projected remediation costs. � pollution legal liability: designed to cover unknown pre-existing conditions, new conditions and associated defense costs. Umbrella coverage and coverage for off-site disposal facilities are available. Marine insurance can be obtained to cover for ocean spills. OTHER INSURANCE In cross-border transactions, the ability to seek recourse against an insurer that is possibly within the same jurisdiction may be of great comfort where the sales proceeds are paid to a company in a different jurisdiction, especially one that does not readily enforce foreign judgments or arbitral awards. Neither party may want the risk, cost and time-involvement of litigation or arbitration in a foreign forum. Coverage is offered by U.S. and U.K. carriers. � Representation and warranty insurance (warranty and indemnification coverage). � Pending litigation insurance (policy covers for loss in excess of a cap). � Aborted transaction coverage. � Marine spill coverage (e.g., for oil companies and commodities traders). � Kidnap insurance (e.g., for oil workers in Latin America). London underwriters advertise that coverage can be arranged for German, Scandinavian, Dutch, Swiss and Austrian transactions. However, it will be difficult to find coverage for pure Italian, Spanish, Eastern European and Russian transactions. In Spain, tax indemnity insurance is difficult. In Germany, the environmental laws are very strict, and in Holland, environmental coverage can be very expensive because of the potential damage from spills where the water table is low. CORRUPT PRACTICES LAWS The U.S. Foreign Corrupt Practices Act (FCPA) prohibits U.S. persons or entities from corruptly making any payment or providing anything else of value to a foreign government official, foreign political parties and their officials, and candidates for foreign political office, for the purpose of influencing any act or decision or securing an improper advantage. The Act also prohibits U.S. persons or entities from making such payments while “knowing” that all or a portion of the payment will be given to a foreign official. The anti-bribery provisions apply to companies with securities registered under the U.S. Securities Exchange Act of 1934 (Issuers) as well as “domestic concerns,” i.e., U.S. citizens and individuals and business entities with a principal place of business in the United States or organized under U.S. laws and other persons who commit prohibited acts while in the United States. Facilitating payments are excepted for routine governmental actions, e.g., processing papers, obtaining permits, obtaining telephone service. Proposed legislation in the United Kingdom will extend domestic anti-bribery laws to offering, accepting or agreeing to accept a bribe abroad. English courts would be given extraterritorial reach. Corporations and their management would be subject to criminal statutes. Civil remedies may also be available. The Convention on Combating Bribery of Foreign Public Officials in International Business Transactions of the Organization for Economic Cooperation and Development (OECD) has been adopted by at least 29 nations including the U.S. and U.K. The Convention covers payments made to obtain an “improper advantage.” Unlike the FCPA, it does not prohibit payments to political parties. Due diligence requires detective work because the object of the due diligence is designed to be hidden. Interviews with employees are important because they often are aware of improper payments. Reviewing travel records and correspondence, searching for unusual wire or cash transfers and compiling lists of “in-country” brokers, consultants and agents are all useful. MONEY LAUNDERING U.S. laws prohibit conducting financial transactions involving the proceeds of a specified unlawful activity with the intent of promoting an unlawful activity, the intent to engage in tax fraud or the intent to avoid a reporting requirement. Banks are required to file a “Suspicious Activity Report” when criminal activity is suspected. U.S. banks have initiated their own “know your customer” (KYC rules) due diligence rules. Switzerland, the land of anonymity, has had KYC rules in place for several years. Accounts are not to be opened without the bank knowing the true identity of the depositor. And more recently, Swiss attorneys have been required to apply KYC rules. Furthermore, Swiss attorneys are required to take a “money laundering” course annually. The United Kingdom has adopted legislation which makes it an offense to assist a criminal obtain, conceal, retain or invest funds if the person knows or suspects that the funds are the proceeds of “criminal conduct.” “Criminal conduct” is defined as conduct that constitutes an indictable offense in England and Wales, e.g., major thefts or fraud. A person suspicious of the activities of another person is protected if such person reports his knowledge or suspicions to law enforcement agencies as early as possible. And, it is an offense to inform the person who is the subject of a suspicion that a report has been made. Client confidentiality is not applicable. Therefore attorneys are caught within the web, being subject to KYC rules. Whenever a tax haven company pops up on an organizational chart, the due diligence expert must inquire as to its purpose. Front up companies such as these often serve as the transit points for illicit payments. If the response is murky, further digging is essential, often by a forensic accountant. As a result of the OECD initiative, various so-called tax havens have enacted legislation to counter being on OECD money laundering lists. For example, as of June 30, 2001, companies organized in The Bahamas no longer may have bearer shares. This law is retroactive. Furthermore, each company must maintain in The Bahamas a register of directors and officers, containing their names and addresses. Bahamian international business companies that offer the services of company formation, registered offices and registered agent facilities are required to maintain records of the beneficial owners. ACCOUNTING Areas of investigation would include, among others: � consistent treatment using GAAP or IAS (IAS is sponsored by the London-based International Accounting Standards Committee); � compatibility of a foreign target’s management information system with that of the purchaser; � tax rulings issued by revenue authorities; � advanced pricing rulings in connection with sales/purchases between related companies; � exchange control regulations. EMPLOYMENT LAW Local law is important. Often, pre-notification must be given where there is an intention to close or move a plant. In Europe, minimum notification periods and severance pay benefits must be considered. Where the target has more than 2,000 employees, an EU target’s works council may have to be consulted before a takeover can occur. (However, the works council does not have the power to veto a transaction.) There is a proposal to require works councils for companies with more than 50 employees. Several countries are strongly opposed to this. Each EU member state is required to adopt legislation whereby the acquirer assumes all obligations under existing employment agreements (with the employee having the right to object to the transfer before the closing.) Benefit consultants and actuaries can assist in meshing pension plans from different companies and different countries. The acquirer must decide how to handle coverage for U.S. citizens and non-resident aliens working for non-U.S. subsidiaries and be prepared to advise employees working abroad as to the tax impact of being transferred from one country to another. CUSTOMS Due diligence is important where the target imports or exports merchandise. A basic customs compliance review can be conducted to uncover potential liabilities and for suggestions to change reporting classifications to reduce duties. Import/export controls should be reviewed for applicability. TAXES Most cross-border transactions are tax driven. Due diligence must include a review of foreign tax returns and reports, e.g., income, sales, capital, gross receipts, value added tax, etc. There should also be a review of rulings or agreements with governmental authorities. In European e-commerce, an important issue is whether VAT is imposed on digitally delivered goods or services by non-EU suppliers to EU consumers. Transfer pricing is high on the “hit list” of revenue authorities. A U.S. subsidiary of the target may sell products manufactured in Ireland with the bulk of the profits from the transaction booked in Switzerland. Is there an intercompany transfer pricing compliance manual? Who is the compliance officer? Are advance pricing rulings in effect? Structure is important. The tax consultant must advise on the use of a new entity or a branch and the choice of a partnership, limited liability company or a corporation; withholding tax rules; the application of bilateral income tax treaties; the availability of tax credits; and so forth. THE INTERNET Searching the Web can secure information in minutes, on a worldwide basis, such as: � filings with regulatory agencies; � credit information; � press releases; � news articles from around the world; � lien databases; � records of judgments; � corporate status, including formation documents and current standing; � registrations such as patents, trademarks and copyrights by the target and by its competitors. Foreign commercial registers often must be checked in person to be certain of liens and encumbrances, and authorized signatories. Today, there are even virtual data rooms. Requested information is scanned and made available over the Internet. This can reduce the purchaser’s travel costs during due diligence. INTELLECTUAL PROPERTY/INTELLECTUAL TECHNOLOGY Intellectual property law lacks worldwide uniformity. Indeed, many countries afford no protection whatsoever. Countries that sign intellectual property treaties may in fact host massive pirating. And, if the product can be downloaded easily, what protection will there be from infringers from nations without protective legislation? A patent may have been filed in one jurisdiction but has it been properly filed and perfected in all other relevant geographic locations? Trademarks may have been filed, but have renewals been filed and has the mark been in use? Foreign “work for hire” rules also must be understood. Although copyrights enjoy certain international protection under conventions and treaties, such protection for certain computer software, especially with regard to protection against non-literal infringement, is likely to depend on local rather than international law. REAL PROPERTY As globalization has spread, so have the opportunities for title insurance coverage. Today, international title insurance policies offer some protection when a company is purchasing foreign real property. This coverage is now available in Ireland, France, Germany, Italy, Spain, Switzerland and the United Kingdom. One title insurance company also advertises that its title insurance is available in South Korea, Singapore, Japan and Hong Kong as well as Australia, Canada, New Zealand, Mexico, parts of Central America and the Caribbean. Coverage is for damage and for costs of defense. Availability depends heavily on a country using a record-keeping system relating to land transactions that establishes the rights of bona fide purchasers. Even where there is a good federal registry system and where the government pays for title losses occurring by reason of an incorrectly registered title, title insurance should be considered. PRIVACY EXPERTS In 1995, the EU adopted a directive on Data Protection to protect individuals about whom data is processed. The U.K. implemented the Directive in its Data Protection Act 1998. In a cross-border acquisition, personal data would include the target’s information concerning its employees. The Directive and the Act restrict the transfer of personal data to countries outside the European Economic Area (the EU, Iceland, Liechtenstein and Norway). Data should not be disclosed without consent. Consent is usually obtained by the individual opting out in writing, or by having prior consent with the individual retaining the right to withdraw the consent at any time. Explicit consent is required for sensitive personal data such as union membership, physical or mental health and racial or ethnic origin. In an acquisition, individuals are unlikely to have consented to disclosure of personal data for purposes of due diligence. It may be difficult to obtain the individual’s consent because the transaction may be confidential. There is a problem if the acquirer is outside the EEA. Personal data cannot be transferred unless the country outside the EEA provides adequate protection. The easiest way to comply is to use the EC’s Standard Clauses for the Transfer of Personal Data to Third Countries. A disadvantage is that these model clauses only address minimum privacy standards. Member states can impose other requirements. CROSS-BORDER TEAM The cross-border due diligence team must include local experts. It must be country specific as well as target specific. Checklists must be customized. Data rooms will be in different jurisdictions. Documents will be in several languages. Local laws, regulations and cultures will be applicable. Local practices will differ. Information uncovered by one national team often must be passed along to other national teams. A coordinator is essential to structure the investigation, engage the members of the team, receive the team’s reports, negotiate confidentiality and data room rules, and have periodic status reports (often via conference telephone calls) during the due diligence period. The need for coordination is critical, especially where the transaction is time sensitive. And perhaps most difficult is the distillation of information for use by the client who ultimately decides which risks are reasonable, which are not and whether the transaction should proceed. For more in-depth information on international due diligence, the authors recommend that readers go to the Reading Room section of the International Bar Association’s Web site, www.ibanet.org. Jon Grouf and Scott D. Newman are partners in the New York office of Kirkpatrick & Lockhart LLP.

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