This article is available here on the website of Thomson Reuters Practical Law, and a short summary without the examples is available here.
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.
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:
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:
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:
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:
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:
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:
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.
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 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?
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
