The Legal Challenges of Private Equity Deal Making in Africa
Private equity is a longstanding component of Africa’s economic landscape. However, strong growth, an expanding middle class, and a global trend that is seeing more investors seeking growth from a broader and more varied range of markets is driving an increased interest in the region. In 2007, Sub-Saharan Africa accounted for approximately 3% of total emerging market fundraising. By 2010, this had doubled to 6%. In 2013, 54% of LP respondents to an EMPEA survey said they were planning to begin or expand commitments in the region. With GDP growth rates well below 2% across most of the developed economies compared with annual growth of 5% or higher in many countries on the continent, Africa’s attractiveness as an investment destination is growing.
As well as Africa-focused fundraising, the total capital invested via private equity transactions in Africa has also continued to rise over recent years. According to EMPEA’s 2012 industry statistics, total private equity investment in Sub- Saharan Africa grew by US$531 million between year-end 2010 and year-end 2012. In 2012, private equity investment in Sub-Saharan Africa reached approximately US$1.16 billion, with a record number of GPs looking to capitalize on the possibility of high returns offered by the continent’s well documented growth prospects. So, with this increase of both investor appetite and capital flows towards the continent, it bears mentioning that firms looking to invest in Africa face a set of unique challenges in identifying and completing deals. One such challenge, which I will explore in this article, is the regulatory issues faced by international investors when completing and/or enforcing deals in Africa.
While Africa offers over 54 bodies of local law, most of these legal systems are strongly based on New York, English or French law. New York and English law provide the most flexible legal background for structuring private equity transactions, as those two bodies of law have been used in cross-border transactions around the world for over a century and have evolved considerably to accommodate the more highly complex transaction structures of recent decades. In terms of sheer volume of transactions historically, the New York and English legal systems are at the forefront. Consequently, an abundance of New York and English-trained judges, arbitrators, barristers and lawyers can be easily found around the globe. Due to the lengthy history and sheer volume of transactions, the members of these two legal fields have more experience to draw from and more creative structuring to offer than their counterparts in any other system.
New York law, in particular, allows for extreme flexibility in contracting with very few limitations on the parties’ freedom to contract. As jurisprudence has advanced, requirements of minimum contact have been relaxed allowing contracting parties broader freedom to choose New York law to govern their contracts. French law has a more limited history in terms of volume of transactions and geographical scope, and while it nonetheless benefits from a longstanding tradition as a legal standard for private transactions, has certain limitations that restrict the parties’ freedom to structure certain desirable contractual remedies, such as the right to put shares back to a company. Similarly, UK law, by comparison to New York law, has attributes that can restrict a contracting party’s ability to execute on certain contract remedies that must be carefully navigated if that body of law is selected to govern a contract where the private equity investor’s exit rights are paramount.
It is often the case that the founders or sponsors of a local company in Africa will initially attempt to insist on local law as the governing law for the investment documentation, on the basis that the transaction is being implemented locally. And indeed often local law is itself based on one of the main legal standards as described above. This could happen in Zambia for example, where the legal system is modeled closely on English law. However, in practice, using local law is extremely limiting and unfavorable to a foreign investor. In the event of a dispute, the parties would need to locate suitable legal experts specialized in the local law as it applies to complex private equity transactions. This is not only limiting but potentially impossible if the universe of such experts is too small. It may also expose the foreign investor to an intrinsic bias that might result from all the experts having a local perspective.
When it comes to selecting a dispute forum, for the time being New York or London are to be preferred, with New York presently offering the greatest advantages to investors. As well as the ready availability of experts, New York courts and arbitration panels are extremely expeditious. Most importantly, they are frequently prepared to extinguish or “stay” a local proceeding. As between the courts and arbitration panel, generally speaking, an arbitration panel in New York applying New York law is preferable to the court, and the federal court in New York (assuming federal jurisdiction can be established) being preferable to the New York state court.
An additional advantage of selecting New York and London as arbitration venues relates to an alarming trend of local shareholders attempting to thwart the agreed contractual remedies and circumvent the agreed choice of law by launching local proceedings on sometimes tenuous grounds such as the “abusive nature of the contract” and general invalidity of contract. This is true even where local sponsors have had the benefit of being advised by sophisticated international legal counsel in the course of document drafting and negotiation. In such cases a foreign investor can find itself battling on two or even three fronts depending upon how many local proceedings are attempted. It is of utmost importance that the arbitration forum selected for dispute resolution have precedent experience in allowing the arbitration panel to stay these other proceedings and compelling the parties to respect their contractually agreed bargain. If a less proven dispute resolution forum is selected, a foreign investor may find itself thwarted simply because the cost and time elements involved in the multijurisdictional proceedings are too prohibitive. New York panels routinely issue these types of “pro-active” stays, and until recently London equally did so.
Equally important is a dispute forum’s willingness to not agree to stay a private equity investor’s right to enforce its negotiated contract breach remedies based on specious local sponsor claims. This in part will be determined by the forum’s threshold standard applied for granting such a “defensive” stay. The preferable forum will apply a higher threshold and will demonstrate a greater intolerance for local sponsor claims that would attempt to circumvent the investor’s benefit of the bargain negotiated in an arm’s length transaction. An example of forum shopping for a favorable court can be seen in IPCO (Nigeria) Limited (IPCO) v. Nigerian National Petroleum Corporation (NNPC). In 2004, IPCO received a US$152 million award from a domestic Nigerian arbitral tribunal. NNPC, the local company, appealed the award to the Nigerian High Court in hopes of having the award overturned; meanwhile IPCO—a subsidiary of a Hong Kong registered company—sought enforcement of the award in the British High Court. After numerous delays in the Nigerian court, in 2008 the British court ruled that the payment of the arbitration award could not continue to be delayed do the local court’s continual delays. The British court ordered that US$50 million of the award be paid immediately.
With all this is mind, foreign investors should favor New York law and venue as the preferred arrangement, with UK law a close second. Although French law and arbitration enjoys a deeply embedded tradition of being a legal standard for PE transactions, it has not proven in recent time to be consistent in backing the rights of foreign investors. It has been noted that French panels are more reluctant to issue the types of stays described above, and they are also often more willing to open the proceedings to notions of fairness which may well result in a contractual bargain appearing particularly onerous in retrospect.
One solution, if an investor has no option but to agree to a jurisdiction other than New York, is that they should add a clear provision to the effect that the arbitrators are required to make the award, and any other decisions or rulings, strictly according to the governing law and not ex aequo et bono or as amiable compositeur, and shall not decide the dispute by reference to any other doctrine or practice that would permit them to avoid the contract in question or the governing law thereof.
It should be noted, however, that in some circumstances local law must be deferred to. These include listing on a local stock exchange, operating according to a concession agreement or matters of corporate governance where local legal entities are involved. In such circumstances, local law will be the reference legal body. However, the freely-negotiated contracts underpinning the other aspects of the investment may still look to laws beyond local law. Moreover, very often once the listing is achieved and the investor’s shares are freely tradable, the shareholders agreement falls away, which would have been negotiated in advance of the listing. Local law is often required to be used for an agreed-form subscription agreement, but that does not prevent the parties from agreeing to additional terms outside such local law-governed subscription agreements that are governed by New York or English law and that augment the rights of the investor.
In summary, we can see that with reported return multiples of 2.5 times on investment, the potential for attractive returns for PE investors in Sub-Saharan Africa is high. Unsurprisingly, these return multiples are capturing the attention of a growing number of international investors keen to capitalize on the continent’s impressive growth trajectory. In committing to opportunities in Africa, however, PE firms must be prepared to act with levels of flexibility, tenacity and resourcefulness that other markets might not demand. This includes attention to detail, the ability to think laterally and readiness to respond quickly to obstacles, regulatory and otherwise, which may not be familiar challenges when operating and investing in the developed markets. In order to do this effectively, the PE manager must have a strong understanding of international standards of best practice as well as a deep knowledge of and penetration within the local market.
About the Author
Carolyn Campbell is a Partner and General Counsel at Emerging Capital Partners, a pan-African private equity investor headquartered in Washington DC. The views expressed are her own.