Anna Triponel | 14 May 2019
This article elaborates on reflections I shared in March 2019 with the company members of the German UN Global Compact Network on the latest developments in integrating human rights into merger and acquisition (M&A) processes. It discusses (1) why weaving consideration for human rights into M&A processes is more and more mainstream, (2) the real challenges to doing so which stem from the very essence of how M&A transactions are undertaken, and (3) five steps to take now for companies seeking to advance this work.
It is primarily intended for company lawyers, wherever they practice law. It will also be helpful for sustainability/ corporate responsibility/ human rights professionals supporting in-house lawyers in this work. It is also relevant for those overseeing the strategic direction of the company, as well as the company’s external lawyers and consultants.
These reflections and insights are based on my work with companies leading in this area, including a number that are part of Shift’s Business Learning Program, and with law firms that are advancing in this area, including a number that are part of the Law Firm Business and Human Rights Peer Learning Process.
Thanks to all those who contributed to these insights. I’m always on the lookout for further examples and views on this topic, please do share yours with me here or over email.
It’s no longer about the ‘why’; it’s now about the ‘how’
The field of ‘human rights and M&A’ has moved on considerably from when the UN Guiding Principles on Business and Human Rights (the UN Guiding Principles) were being developed ten years ago. Back then, I was sitting at a law firm desk in New York, juggling M&A deals on a billable basis, and pro bono work for John Ruggie (the UN Secretary-General’s Special Representative for Business and Human Rights) on a non-billable basis. The number of people who considered that human rights and M&A could and should be considered together could be counted on the fingers of one hand – maybe two.
Rapidly after the UN Guiding Principles were endorsed at the highest UN levels in 2011, setting a clear expectation of all companies to consider and manage human rights impacts they could be connected to throughout their business regardless of applicable national laws, leading companies started to think about what this human rights responsibility meant in practice when acquiring new businesses or divesting old ones.
Today, the field has moved on even further. We are witnessing a significant change: the question of why lawyers should do this is being replaced by how they should do it. There are a variety of reasons that explain why a large number of companies, followed closely by law firms, are meaningfully asking themselves how they can strengthen their M&A processes to look beyond legal compliance to capture human rights risks.
We now have a number of laws that expect or require companies to conduct human rights due diligence, including in their operations overseas and with their business partners. These include:
- the 2010 California Transparency in Supply Chains Act;
- the 2015 UK Modern Slavery Act;
- the 2017 French Law related to Duty of Vigilance of Parent Companies and Commissioning Companies; and
- the 2018 Australian Modern Slavery Act.
And this direction of travel will only continue, as evidenced by recent discussions in Switzerland, the Netherlands, Germany, Canada and Hong Kong.
Combine these expectations of multinational companies in their home jurisdictions, with the applicable laws on the ground in host countries that may fall short of international standards, and we see that the traditional “compliance with laws” representation provided by sellers in the course of M&A transactions provides little comfort to buyers. The following are just a few examples:
- If the seller has provided a representation that the target’s business has been operated in accordance with applicable laws, and the target is operating in a country where national laws fall significantly short of international standards, would this representation have any value if the buyer is subsequently brought to account in front of a mechanism created in its home country (an OECD National Contact Point) intended to assess company compliance with international standards? This situation would occur for instance where the law excludes a group from legal recognition which in turn legalises discrimination (e.g. the Rohingya in Myanmar), legalises child labour (e.g. of children aged ten and over whom are legally authorised to work in Bolivia) or facilitates community disempowerment when acquiring land (e.g. because community land rights are not secure).
- If the buyer is subject to a law that requires a certain level of human rights due diligence on its business partners (e.g. the French duty of vigilance law), would the buyer’s liability be affected when acquiring a company that is legally compliant but responsible for ongoing human rights violations overseas?
- If the buyer’s business partners have requested that the buyer put certain human rights-related policies and procedures in place to enable them to comply with relevant laws (e.g. the UK Modern Slavery Act), would this buyer’s purchase of a company that does not have any procedures in place and/or instances of bonded labour in its value chain impact the buyer’s contractual liability?
Rise in law suits
We now have a surge in law suits against companies for allegations of past human rights violations, including those that took place on the target company’s watch. A recent study conducted for the European Parliament identified 35 recent cases of alleged human rights abuses of EU-based companies in third countries. This study highlighted the rise of lawsuits in EU jurisdictions based on incidents happening in low and middle-income countries.
Another recent study reviewed the human rights-related litigation cases and remarked on the high financial costs of such law suits, including the damage to a company’s reputation and credit rating, no matter the final court decision. The rapid increase in these law suits and the uncertainty surrounding them make it particularly challenging to anticipate and quantify them, resulting in acquisitions that can end up becoming significantly more costly than anticipated. The following are a few examples:
- When German pharmaceutical company Bayer acquired US agrochemical company Monsanto in June 2018, did it accurately value the financial and reputational implications of Monsanto’s use of glyphosate in its herbicides? Two months later, newly-purchased Monsanto was ordered by a Californian court to pay damages of $289,2 million, resulting in a loss of $10 billion in Bayer’s market capitalization over the course of just a few hours (the equivalent of 16% of the acquisition price). The damage for Bayer resulting from this acquisition is continuing to this day and includes 9,000 legal claims in the US and $3.8 billion in impairments.
- When US chemical company Dow Chemical acquired Union Carbide Corporation (UCC), another US chemical company, 16 years after the Bhopal industrial disaster in India that happened on UCC’s watch, did it anticipate the loss of business opportunities in India and the intense campaign that would ensue around its sponsorship of the 2012 London Olympics? The fact that the agreement was carefully structured so as to ensure that Dow Chemical did not legally assume UCC’s liabilities did not protect it from financial or reputational harm.
- When French construction materials company Lafarge purchased its Swiss equivalent Holcim for €41 billion in July 2015, did Holcim uncover in the course of its seller due diligence that employees at Lafarge’s Jalabiya plant in Syria had paid billions of euros to armed groups (including the Islamic State) to keep the plant open? Would Holcim have agreed to the deal knowing that a few years later the combined company would be charged in French courts with complicity in crimes against humanity and ordered to hand over €30 million as a security deposit? The case is said to have resulted in the first CEO after the merger stepping down and in seizures of executive severance payments. To illustrate the lack of certainty surrounding litigation in this area, this was the first time in the world a parent company was indicted for complicity in crimes against humanity, and the first time a multinational was indicted in France for the activities of its subsidiary overseas. A recent UK Supreme Court judgment reinforces that this is a growing trend. UK parent company Vedanta (a mining company) was found to owe a duty of care to non-employees impacted by its Zambian subsidiary Konkola Copper Mines in the Chingola District of Zambia.
We now have investors that are increasingly engaging with, ranking – and even ready to divest from – companies based on their human rights behaviour. John Ruggie recently reported that ESG investing now accounts for nearly $31 trillion (which corresponds to more than 25% of assets under management worldwide), and that this global upward trend in ESG investing is likely to be reinforced as an increasing number of millennial investors are poised to invest.
An acquisition can change the company’s risk profile in the eyes of investors overnight. It can lead the buyer to become a high investment risk, warranting increased engagement from its investors and/or a decrease in the investors’ rankings, or even removal from rankings and divestments. The following are a few examples:
- Following a transaction, the company with the stronger approach to human rights due diligence will most likely find its approach diluted, especially where it is the one being acquired. Consider the example of the purchase of UK-based South African brewer SABMiller by Belgium-based brewer Anheuser-Busch InBev (AB InBev) in 2016. The resulting combined company ranked very poorly (<10%) on the Corporate Human Rights Benchmark in 2017, an investor ranking assessing 101 of the largest publicly traded companies in the world. It is generally thought that SABMiller would have ranked higher if ranked on the strength of its policies and processes alone. The company has since increased its score to 20-30% suggesting that SABMiller’s approach to human rights may have in time transferred over to the combined company. Consider also the impact the takeover bid from American food and beverage company Kraft Heinz, one of the lowest-ranked companies on the investor benchmark (0-10%) would have had on Unilever’s ranking. Anglo-Dutch consumer products company Unilever is one of the highest-ranked companies on the investor benchmark (60-70%) and may have never enjoyed similar investor ranking following this transaction.
- A number of pension funds and other investors divested from Anglo-Australian mining company BHP in light of its 50-50 joint venture with Brazilian mining company Vale that resulted in the Samarco 2015 dam disaster in Brazil. The fact that BHP had limited control under the prevailing legal arrangements was not viewed as important in the eyes of investors: to the contrary, the lower the control, the higher the likelihood of an impact occurring. In response, the company announced its intention to unwind all mining ventures it had no operational control over and made a number of commitments to increase its oversight of joint ventures. (Of particular note, a dam failure that happened three years later at another dam owned by Vale resulted in investor divestments as well as the exclusion of Vale from the investor benchmark.)
We also have companies that are committing publicly to integrating human rights due diligence into their M&A transactions, and that are pushing the boundaries of the use of contracts to do so. A number of companies that are part of Shift’s Business Learning Program have done so for instance. There are a number of reasons for companies choosing to do this, including a desire to meet their internal values and/or to meet international expectations of them under the UN Guiding Principles, as well as protecting their reputation and positioning themselves as a brand of choice – both for future employees as well as potential customers.
Protecting one’s reputation is a particularly important driver for seeking to consider human rights risks when it comes to divestitures. This is particularly noteworthy since much of a company’s leverage as a seller is typically lost post-contract. The following are a few examples:
- Consider the example of Unilever who notes that its approach of integrating human rights and other sustainability considerations into M&A “makes us an attractive buyer to many companies/ shareholders who share our values and can be an important differentiator in a field of bidders.” This commitment translates into action, including in its disposals. As one of the world’s major buyers of palm oil, Unilever committed publicly to source 100% of its palm oil from suppliers sustainably by 2019. When the company sold its Spread business to US global investment firm KKR, the company specifically requested the same commitment from the buyer.
- I previously wrote about Finnish telecommunication company Nokia Network which suffered reputational damage for selling a business to Iranian telecommunication company Iran Telecom which could be used to track and harm end-users in Iran. Nokia subsequently acknowledged publicly that it should have better understood the human rights implications before the sale and has since developed a process to assess whether there is a significant potential that sales of products and services could be used to infringe human rights. In particular, the company has created a senior-level internal review process that provides limitations on sales deemed as high risk when it comes to human rights, in particular where local law or its interpretation conflict with international human rights standards.
There is also an increasing risk to a company’s operations where human rights risks are not considered. Post-acquisition, this can lead to unanticipated stoppages to operations, community protests, worker strikes or consumer boycotts. This can even lead to the need to exit the acquired project. The following are a few examples:
- I previously wrote about US mining company Meridian Gold which acquired Brancote Holdings — the UK-based mining company owner of the El Desquite mine site in resource-rich Patagonia in Argentina — for US$320 million. Although legal due diligence did not uncover any issues and the title to land was legal, Meridian Gold ended up with five years of litigation rising to the Argentinian Supreme Court, and lost its entire investment because the community at the neighbouring town of Esquel opposed the use of the land for an open-pit gold mine. This case highlighted the pitfalls of taking a top down approach to mining, without seeking to understand cultural specificities and the needs of local communities. Meridian Gold subsequently sold the site to Yamana Gold. After realising as a result of a second referendum that the local communities remained opposed to gold mining, Yamana Gold decided to take a different approach: the company has initiated a conversation on the sustainable development of natural resources in the region with a range of stakeholders, including local residents, universities and the provincial government. The company is of the view that it is preferable for them to build a strong understanding of human rights-related risks, including how to manage them, than to push for this specific project to come onstream.
- Another well-known example is that of American oil and gas company Exxon’s $81 billion acquisition of American oil company Mobil in 1998 – the largest corporate merger at the time. At the time of the acquisition, Mobil had extensive holdings in Southeast Asia and Africa in a number of challenging operating environments, including Chad, Nigeria, Equatorial New Guinea, and Indonesia. In Indonesia, Mobil, and subsequently, ExxonMobil, relied on the Indonesian military to protect its facilities, in a context of a worsening civil war with a separatist group seeking independence for the Aceh region. To quote Pulitzer prize-winning writer Steven Coll, when the CEO of Exxon “acquired Mobil Oil, he also acquired a small war. In any merger, the acquiring party often finds that the target company has a few problems that are worse than expected. Mobil’s role as a party in one of fractious Indonesia’s most violent separatist insurgencies quickly emerged as such a case.” Exxon found itself confronted with issues that it had not anticipated and that it was ill prepared to respond to, including violence against employees, lawsuits against the company and shut downs, leading to its decision to exit the project. Steve Coll calls the merger a “fiasco” for Exxon.
- In another recent example based on a law firm’s experience, the due diligence on a transaction failed to identify that modern slavery was occurring on the site of the target company. This modern slavery was taking place in a business that was seen as ancillary to the core business and therefore was seen as low risk and excluded from due diligence. The fact that modern slavery was taking place was subsequently identified during the course of an internal compliance monitoring exercise. The implications for the buyer are ongoing, but the buyer has since advised all its M&A lawyers to consider human rights risks in all future M&A transactions.
In addition to these reasons, considering human rights risks is also increasingly expected of lawyers as the business world they are advising is rapidly evolving. The International Bar Association (IBA) specifically elaborates on this in its practical guide for business lawyers. The law in this field is “dynamic and evolving” and “[l]awyers are uniquely positioned to advise clients” on where the law is going. Further, lawyers can “act as wise professional counsellors and enhance the value of their services by providing appropriate human rights context for their legal advice and services.” M&A is one practice area in particular where lawyers play a role in shaping a company’s ability to respect human rights, and the IBA has provided further guidance in this area.
Today it’s no longer about the ‘why’; it’s now about the ‘how.’ But to fully advance on this, it is important to first understand the inherent challenges when it comes to streamlining consideration for human rights into M&A processes.
The challenges: why there is no easy solution
Any M&A lawyer undertaking this work will know, there are some very real challenges to integrating human rights into M&A processes in a systematic and business-friendly manner. To be successful, an approach to integrating human rights into M&A needs to acknowledge these challenges, and build on them so that the proposed process reflects the essence of how M&A transactions are conducted.
Although there are others, the most significant hurdles that I see are as follows.
The tight timing and confidentiality on M&A deals makes it particularly challenging to fully assess human rights risks
The buyer is typically competing with other buyers and is doing its utmost to assess risks in a short period of time and demonstrate that it is the preferable buyer. Once the target company has shared its internal documents, the due diligence phase kicks in, and there are already a lot of risks to consider, including tax, litigation, intellectual property, employment relations and environmental. Human rights is just one area amongst many and with limited time, this is likely not going to be seen as one of the most material issues for the transaction.
In addition, the tight confidentiality, which is particularly acute in the course of a public bidding process, complicates meaningful due diligence in this area. It will be challenging to pick up the phone to, for instance, the local representative of a global trade union or a well-informed civil society organisation on the issues in a specific country, without possibly giving away who the client is and being seen as tipping off the market on the potential acquisition. How then can one conduct meaningful due diligence, especially in areas where the availability of desktop resources is limited? What kind of desktop resources are suitable, and who else can the lawyers speak to?
Considering human rights risks entails taking an approach which is fundamentally different to how lawyers are traditionally trained
M&A lawyers are trained and expected to protect the company they work for. They quantify the legal implications of the risks they identify, focusing on where the financial and legal risks are the greatest. They limit their due diligence to direct business relationships, since this is where the legal risks typically lie.
However, an approach of considering human rights risks aligned with soft law expectations entails focusing on identifying where the most people may have been harmed in the most severe way, including beyond tier one. This is known as where the company has its ‘salient human rights issues’ (this terminology and the approach expected of companies to identify their salient human rights issues is further described in the UN Guiding Principles Reporting Framework). This expectation under soft law explains why an increasing number of companies are seeking to map their extended supply chains and conduct due diligence beyond their tier one business relationships. When applied to the M&A context, the company is viewed under soft law as acquiring the target company’s salient human rights issues, which includes those present beyond the target company’s first tier business relationships, regardless of how the acquisition is legally structured and regardless of the risk to the business. This is not something that M&A lawyers are accustomed to considering.
A second major difference relates to how lawyers use contractual protection to address the issues they find in the course of due diligence. In a traditional approach, whenever they can, lawyers seek to pass the risk on to the other side and limit their company’s exposure to it. For instance, they could seek to reduce the company’s control (in a joint venture) or exclude certain assets from the acquisition (in a purchase of assets).
However, an approach of addressing human rights risks aligned with soft law expectations entails finding ways – through the M&A transaction or otherwise – of addressing this harm. This latter approach could entail for instance requesting settlement for issues that have been identified, rather than seeking to ensure no legal liability for them, or simply negotiating a reduction in the purchase price to be able to address these issues post-transaction.
The difficulty of quantifying the materiality of human rights risks leads to human rights risks going unidentified
Materiality as applied to M&A deals means that issues that do not arise to a certain level (which can be set at a specific monetary amount and varies depending on the transaction) are not typically considered as part of the due diligence or the contractual protection. While this is an effective way of ensuring that the legal team focuses on the issues that carry greatest financial risk for the buyer, this focus on materiality is particularly problematic for human rights risks. As discussed above, laws, litigation, consumer pressure, reputational damage and other factors increasingly lead to human rights risks becoming material to companies. However, because this field is evolving so rapidly and is still new to the majority of M&A lawyers, most human rights risks are typically not readily quantifiable by the M&A team at the time of the transaction. Therefore, even where the risks are identified, they can be improperly quantified and left to the side.
In addition, the buyer may wish to know about issues because of the risks to people they represent – regardless of their impact on the bottom line of the transaction. As described above, an increasing number of companies are seeking to assess and tackle their salient human rights issues (i.e. where the risks to people are the most severe and the most likely as a result of the business they are undertaking). However, where these companies are using materiality as the threshold for issues to consider in an M&A transaction, they are inadvertently excluding from focus all severe human rights issues in the target company that are not seen as immediately having high financial implications.
M&A transactions are typically premised on compliance with applicable laws, often based on information provided by the target company and local counsel
There are limits to the usefulness of the information a target company can provide. The company may not know itself about its own human rights-related impacts and their implications. And even if it does, it may be able to hide behind disclosure of the existence of policies and processes, which fail to capture the effectiveness of these systems. Ill-crafted enquiries in due diligence checklists coupled with poorly drafted representations and warranties in the resulting contract can inadvertently help support this use of smoke and mirrors. Further, local counsel may not be aware of how human rights risks can manifest, or may be too close to them to flag them as potential issues, especially where human rights impacts are culturally accepted. Finally, as described above, the typical “compliance with laws” representation gives little comfort to a buyer where the law is below or inconsistent with international standards, especially since the buyer is increasingly being held to the application of international standards abroad in its home jurisdiction and by its key stakeholders, including investors and consumers.
Internal silos decrease the company’s ability to assess human rights risks in the course of the transaction
Other teams (e.g. sustainability, human rights, corporate responsibility, human resources, procurement) may have strong insights into potential human rights risks in the sector, business activities or country being considered in the transaction, but they are commonly not brought in in time to provide insights that can in turn lead to tailored due diligence and contractual protection. These teams are typically brought in once the legal deal has been completed and they are asked to play a role in the integration process, by which time what one could have requested of the target company is no longer on the table. Internal silos can also lead to the M&A team identifying some human rights risks and deciding that these would be better addressed post-acquisition (rather than in the contract), but failing to pass these issues on to the integrating business to be addressed.
Recognising the inherent challenges to weaving consideration for human rights into M&A process does not mean we should not do it: quite the contrary, it increases the need for it. Having full knowledge of these barriers will in turn help support M&A lawyers in doing so, in a sustainable and business-friendly way, while staying true to the expectations on them when it comes to human rights respect.
Five steps to take now
We have discussed why it is increasingly compelling for companies to consider human rights risks as part of their M&A transactions, and why it is challenging to do so. Here are five key steps companies can take now.
1) Anticipate where the business is going, and tailor the human rights and M&A strategy accordingly
What is your company’s business strategy? If you don’t know, who can you connect with in the business to find out? Is your company going to be seeking growth through small acquisitions in a niche market? Is your company looking to certain markets in certain geographies in particular? Is the company interested in expanding into a business area that has a high propensity for human rights issues? Is the idea to dispose of all non-core assets? Will company culture play a role in your company’s choice of acquisitions? A better understanding of the company’s future business strategy will in turn help tailor the approach and focus on where the risks may be the greatest in this strategy. One company I worked with had a strategy nearly entirely focused on disposals. Some of these disposals could be seen as carrying particular risk when it came to human rights. The company therefore focused its efforts on its seller due diligence and enhancing what it could request in the contract in the course of its disposals.
2) Build the case for considering human rights in the course of the transaction before the target company is in sight
M&A transactions happen quickly and the focus is traditionally on issues that are seen as material to the transaction. As described above, it is exceedingly difficult to accurately value the financial impact of human rights risks. Another company I worked with compiled a note for its M&A lawyers of the kinds of risks that could have been identified and accurately valued in the course of M&A due diligence, had human rights been considered at the time of the transaction, rather than post-acquisition only. This helped set the stage for future M&A transactions.
3) Build the knowledge of M&A lawyers to understand the basics of what makes a deal higher risk when it comes to human rights and equip them with the support, tools and processes needed to build on this knowledge
M&A lawyers are not expected to become human rights experts. However, they do need to have sufficient understanding to be able to recognise when human rights risks may be a particular issue for the company to consider. This is no different to other areas of risk, such as tax, intellectual property and environmental issues. Integrating this knowledge into the company’s M&A process is the best way forward: once it’s a ‘go’, the M&A lawyers can reach a high level assessment of the risks based on desktop information and the information they receive from their bolstered due diligence checklist, and know where to go within their own company for further support on due diligence where needed (e.g. the corporate responsibility team, the ethics team, the land acquisition team). One company I worked with conducted a training for all of its M&A lawyers and put together a ‘red flag cheat sheet’ that sought to equip the M&A lawyers to know when to ‘raise the hand’ and escalate deals for further human rights-specific due diligence. The stronger the due diligence phase, the easier the contractual protection and post-acquisition phases will be.
4) Find ways of breaking down internal silos between M&A and those in the business that have visibility into how these risks manifest
Internal silos decrease the company’s ability to assess human rights risks. As described above, a number of teams may have strong insights into potential risks, but are not brought in in time to provide insights on the risks before closing a deal. To tackle this, one company I worked with created a working group which would decide at the outset of due diligence whether this was a transaction with greater human rights risks, warranting the inclusion of the the human rights team in the due diligence. Another company decided to put processes in place to enable its sustainability specialists to play a greater role systematically in the course of due diligence. This entailed providing a list of all transactions to its sustainability team on an ongoing basis and requested data room access for sustainability specialists to review documents, in parallel to the M&A lawyers.
5) Identify where the human rights responsibility companies are subject to differs from an approach grounded on legal liability, and find ways of navigating this new reality
As described above, there are differences between taking a traditional legal approach to M&A, and taking an approach premised on a company’s responsibility for its human rights impacts as described in soft law. Understanding this distinction will in turn help the company get the most value from the lawyers’ expertise. Lawyers can play a critical role in helping companies address issues identified, including advising on what can be requested of the target company in between signing and closing and where bespoke indemnities for identified issues may be helpful – as long as they are aware of the company’s broader goal of seeking to address the issues, in addition to protecting the company from legal liability.
M&A lawyers play a significant role in helping a company meet its responsibility to respect human rights, especially where a company may be seeking to acquire businesses operating in countries that fall short of international standards. At the same time, the responsibility cannot fall on their shoulders alone. At the end of the day, the transaction-specific due diligence and contractual protection can only go so far: post-closing, the leverage with the other side is lost. The work of addressing human rights impacts once an entity is acquired will then fall to the integration team within the buying company. Ultimately, the robustness of a company’s broader human rights due diligence approach, and how it is rolled out to the entire business, is crucial to helping ensure this company can meet legal requirements, both current and upcoming, as well as international expectations.