Within the movement to “reform” the Foreign Corruption Practices Act (FCPA), one of the key platforms is limiting or eliminating successor liability. Holding one company responsible for the prior bad acts of a different company seems wrong. Add to that the fact that acquiring companies won’t and can’t know about purchased companies’ bribery, and the unfairness of continuing liability through a change in ownership—and possibly even a change in corporate structure—is manifest.

The Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) don’t see it that way. Successor liability has its basis in legal history—the idea that “when you buy a company, you buy its liability” is highly ingrained—and in legal theory. But is that always the case?

This question recently arose in the context of a malpractice action. Several months ago, the SEC settled an enforcement action with a company named Watts Water Technologies Inc. in relation to its China subsidiary. The subsidiary had, prior to the purchase by Watts Water, obtained contracts through bribery.

When Watts Water purchased the Chinese company, the acquisition was an asset purchase rather than a stock purchase. The company’s outside counsel believed  that an asset purchase would not subject the company to the follow-on liability for past conduct of the acquired company.

I have a hard time agreeing.

I’m trying to imagine the circumstance under which that argument would work with the DOJ or SEC. The argument, in my opinion, is especially weak when the acquirer purchases all, or mostly all, of the assets. It seems like the company is trying to avoid liability based on the legal technicality of the type of transaction. 

But why would liability follow an asset purchase? For the DOJ, and criminal liability, the entire concept—holding someone who could have no knowledge of the underlying criminality—is problematic. Certainly, individual liability for corporate officers of the purchaser is impossible. Criminal liability requires corrupt intent, and absent extraordinary circumstances, that can’t happen in the context of an acquisition.

Civil liability is a different beast. First, there is no knowledge requirement for violations of the books and records provisions of the FCPA, so proving why the records are wrong, or that someone intentionally misrecorded a payment, isn’t necessary.

More importantly, when a company wins a contract through bribery, the resulting revenue from that contract is tainted. The taint remains throughout the life of the contract. When the company is purchased, the tainted revenue flows into the coffers of the acquiring company. The bribes can—and often do—continue after the purchase.  In fact, if the company doesn’t find the bribes during the pre-acquisition due diligence, the bribes will likely continue.

And companies are motivated to uncover fraud in pre-acquisition due diligence. If due diligence finds the anti-corruption problem, the purchaser can first and foremost properly value the acquisition and its assets. A company saddled with a hidden, massive potential FCPA liability isn’t worth as much as a company without that liability. And the amounts—given the enforcement trends—can quickly become material.

If a company finds the bribery, it can either remove the improperly acquired revenue from the valuation and cancel the contracts, or it can walk away. In either case, liability is averted.

Diligence is done no matter what type of transaction, asset or stock purchase is used to acquire the target company. And because liability would generally be predicated on the post-acquisition effects of the prior bribery, that would also tend to make the type of transaction irrelevant.

Finally, post-acquisition compliance enhancements would serve both to potentially detect previously undetected misconduct and to show the DOJ or the SEC that the new, merged corporation, in whatever form, rejects the past bad acts of its new subsidiary. 

By telling a better story to the DOJ and the SEC, a company stands a much better chance at having enforcement agencies decline prosecution. Certainly, telling a better story includes not seeming like you’re making legal technical excuses to rationalize bad behavior.