Julian Jackson is an English solicitor and a director of Africa Legal, the Africa-specialised division of Deneys Reitz www.africalegal.co.za.
Africa is a diverse and dynamic continent that offers investors a wealth of opportunities, a fact reflected in increasing levels of international and cross-border investment activity. In common with all emerging markets, however, Africa can be a complex and risky environment in which to operate, being subject to a wide variety of laws, regulations and business practices. Obstacles which entrepreneurs may encounter in sub-Saharan Africa can include, depending on the country in question, political risks, currency availability/exchange risks, lack of infrastructure, skills shortages, lack of transparency/corporate accountability, and corruption.
These emerging-market risks pose special challenges, both for deal-makers and their lawyers. Traditionally they have elicited two very different responses from investors.
The first response, applicable mainly (though not only) to the largest transactions such as international infrastructure projects, is to take a "belt-and-braces" approach to legal risk, in line with standard international practice. These big deals tend to be driven from major international centres, such as London or Washington, and involve heavy participation of legal and other advisers. Emerging market risk is reflected in correspondingly complex deal structures, which often involve seeking ways of mitigating political risk (through political risk insurance, risk guarantees and/or multilateral agency involvement), taking sophisticated insurance cover, as well as negotiating complex financing and security measures which seek to overcome deal-specific risks.
The alternative approach is often encountered on small and medium sized investments – the primary focus of this article since these form the bulk of most commercial investments in Africa - with investors attaching limited importance to the legal process as a way of protecting their investment. This can be because the cost of legal advice is perceived to be high (especially if it is required both at home and in the local jurisdiction) whilst the promise of success in terms of legal enforcement is perceived to be low. Hence, deal-makers often take a view on legal risk and work on the basis that if the commercial relationship should come under such strain that contracts need to be enforced, the investment has been lost anyway, so there is no point incurring much time or money on legal input. Indeed, it is not uncommon to come across transactions involving international investors where the legal documentation is far inferior to that which the same investors would insist on for a comparable deal in their home countries. The view seems to be that since making the investment in the first place is a risk, some additional legal risk won’t hurt.
Yet with proper due diligence and tighter structuring, fewer things are likely to go wrong. And when they do, the availability of appropriate legal remedies can significantly improve the outlook in an otherwise bleak situation. That being so, why do some investors adopt the laissez-faire approach?
Commonly, this originates from three widely held misconceptions: firstly, that the legal process only begins at the documentation stage; secondly, that legal documentation only starts performing a significant function when the deal goes wrong, and thirdly, that legal remedies are ineffectual in most of Africa. These views are erroneous in several respects.
Regarding the first, one of the most valuable functions of the legal process (particularly in an emerging market context) is to work with the client to identify fatal flaws and key risk areas before the client has become so inextricably committed that it would be difficult or costly to withdraw from a prospective investment. For example, a deal may be structured in a way that would in fact be illegal for the investor. Or, certain business practices in the investee entity may be common and accepted locally but they might not be in accordance with international practice (for example, on governance issues). Where transactions involve regulatory questions, a common stumbling block can be the relative uncertainty or lack of precision of local regulatory regimes raising the possibility of regulatory risks which are difficult to quantify. Far better to become aware of any such risks early on in the process and thereby be able to respond or, if that is impossible, to avoid the costs of a late abortive transaction (or worse - if the transaction has already been concluded).
With regard to the second, legal documentation, arguably the most important function of a legal contract is to avoid disputes arising in the first place. It is not unusual for the parties only to become aware of material issues at the drafting stage. A good lawyer will assist the process by setting out the material terms clearly and simply in a well-structured contract. Investors who take short-cuts with the documentation can significantly increase the likelihood of disputes.
Regarding the third, enforcement, whilst it is true that the legal systems in certain African countries can be slow and/or unpredictable, it is possible to minimise the risks for clients significantly. Experienced lawyers will advise clients on unusual legal risks which may apply in the target country, and any mitigation possibilities. It may be possible, for example, to minimise the need for recourse to local courts, or avoid it altogether, by choosing foreign laws and tribunals, such as international arbitration, or by choosing another acceptable jurisdiction. The choice of tribunal may also affect the availability of remedies - in some countries, remedies available locally through enforcement of arbitration awards may be significantly more favourable than through enforcement of foreign judgments, while in others the enforcement of arbitration awards is difficult. And there may also be bilateral or multilateral investment protections available to the investor.
South African investors may encounter resistance to a stipulation that South African law should govern the contracts if it is seen as unfamiliar or not neutral. A neutral choice which often finds better acceptance is English law, not only because it is increasingly the law of choice for international contracts, but also because in Commonwealth countries it is analogous to the local law in many respects.
Analysis of the assumptions on which the laissez-faire approach is based suggests that there is little to recommend it, even where investors are severely constrained in their legal budgets. That said, investment in the emerging markets does demand particular skills of the lawyers. As well as having a firm understanding of the wider commercial and geopolitical context of a deal, the lawyer must be practical and realistic about the levels of legal/documentary protection that both are appropriate and can be achieved.- a common mistake is to produce documents in the style of the home jurisdiction without consideration for local business and legal customs. Certain provisions (such as extensive warranty protection) which are common in more sophisticated legal markets may not be acceptable to local counterparties and may cause irritation and/or offence. Yet other issues that are pertinent locally (for example, involving local customary rights or issues of wider social significance) may be missed altogether.
For these reasons, access to quality local lawyers is also an essential consideration when contemplating cross-border investment activity. Reliable local advice can be difficult to find (particularly in the smaller markets), and it is therefore critical that local counsel is identified as early as possible in the process.
The legal and business landscape in Africa is so diverse that it is difficult to generalise about the correct levels of legal input on investment transactions, and the extent and efficacy of legal protections which one can reasonably hope to end up with varies from deal to deal. However, experience has repeatedly shown that timely and appropriate legal input can make a critical difference in avoiding and mitigating risks for investors. The considered use of suitably experienced legal advisers will almost invariably prove to be a worthwhile component of the overall transaction costs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.