'Red flags' for lenders investing in emerging markets: recent High Court guidance

Emerging markets offer a wealth of opportunity across a wide range of sectors. Yet there can be a catch, even for sophisticated parties, especially financial institutions: a greater number of risk indicators, or 'red flags', that could require investigation when negotiating a potential transaction. As reported in a piece shared in our Eye on Emerging Markets update from July this year, state involvement in commercial transactions continues to increase and can bring an even greater level of legal risk for commercial parties in those jurisdictions, in part due to the necessary involvement of public officials.

The recent decision in the "tuna bonds" claim brought by the Republic of Mozambique ("Mozambique") against Privinvest, a shipbuilding company, and several banks providing the funding for the project, serves as a helpful reminder for banks and other institutions looking to capitalise on opportunities in emerging markets of key issues that may be indicative of 'red flags' when engaging with states and public officials in such markets. This article focuses on bribery related issues. Of course, immunity is another risk issue when transacting with states/state entities. A detailed analysis of sovereign immunity under UK and US law can be found in the piece linked above.

Risk Indicators, or 'red flags'

In the context of its claim in corruption and bribery, Mozambique accused many of the lenders involved of having "actual or constructive" knowledge of 94 'red flags'. Importantly, rather than being indications that the lenders had done something wrong, the judge seemed to accept Privinvest's submissions that they instead might simply indicate that a lender is required to do something, for example undertake additional due diligence or take responsibility for ensuring that certain disclosures are made to the relevant organisations or individuals.

Due to the settlements between Mozambique and the banks, the Hon Mr Justice Knowles did not make any liability findings against them, but he did state that "the regulatory, professional and reputational position for these banks may be severely exposed, with economic and operational consequences".

The red flags were summarised by the judge and some key takeaways are set out below.

It is imperative to carry out due diligence on:

• Any contracting state, with particular regard to corruption, governance and transparency.
• Key players in the transactions, noting any reputation relating to bribes, corrupt practices.
• Any surprising project leaders, e.g. public servants with a lack of experience in the area.

It is important to obtain:

• Reasons for lack of public procurement or a competitive tender process.
• Valuation of any assets and services to be supplied.
• Reasoning for structuring lending as a loan to an SPV coupled with a State guarantee, especially when this serves to avoid Public Procurement Regulations.
• Confirmation that any guarantees and guarantee confirmations do not exceed the guarantee limit in the relevant State Budget Laws.

Finally, if an unusually high return is ultimately offered to the banks, it is important to question why.

Brief bribery refresher

In English law, the components of a claim for bribery are:

• that a secret payment or other inducement has been made to an agent which gives rise to a realistic prospect of a conflict between the agent’s personal interest and that of his principal;
• the recipient of the bribe (or the person at whose order the bribe is made) must be someone with a role in the decision-making process in relation to the transaction in question.

Notably, where there has been bribery, it is not necessary to establish dishonest or corrupt motives before a finding of bribery can be made.

Additionally, the fact that the supply contracts were valid and on commercial terms is not relevant to the question of a defendant's liability to account for the bribe.

Beware illusions of legitimacy

There were a number of factors which might have appeared to those involved to give the projects legitimacy and value, but which were not enough to defeat a finding of bribery:

1. Mozambique knew it needed what was to be supplied;
2. the quality of the assets supplied was not lacking;
3. the projects were no secret to Mozambique and had the support of many Mozambican officials who were not bribed;
4. the current President of Mozambique, then its Defence Minister, was not found to have received any bribe and himself instructed the then Finance Minister to sign the guarantees for the projects;
5. the judge was unable to identify a single senior official or office holder who over the period 2011-2015 challenged the projects;
6. knowledge of a senior official or holder of public office, even a President, of a bribe is not sufficient to attribute knowledge to Mozambique; only disclosure to the Assembly of Mozambique would have sufficed.

Conclusion

Parties looking to make the most of opportunities in emerging markets, particularly where those jurisdictions have a reputation for corruption, must ensure that their checks and due diligence are thorough and careful in the event a deal collapses and is the subject of a dispute. The potentially higher returns from investing in emerging markets can come with higher risk. There is therefore greater obligation on sophisticated parties, particularly regulated institutions with robust compliance functions and obligations, to ensure that they identify red flags and take the necessary additional steps. This judgment is a useful guide on some of the key issues which could give rise to red flags when engaging with states and public officials in emerging markets.