International transactions: legal risks and mitigation strategies

28 November 2008

South Africa’s trade and investment with the rest of the world, and in particular the rest of Africa, has grown rapidly since South Africa emerged from international isolation in 1994. The country has positioned itself as a gateway into Africa and many international financial and other institutions have established regional offices, often as a platform for operations into the rest of the continent. Many South African businesses are now represented internationally and/or transact across national frontiers. The comparatively strong performance of several African stock exchanges, the increased world-wide demand for resources and commodities and the general scramble by developed countries to find non-matured markets for their products has also contributed to an internationalising trend.

But cross-border transactions create complexities, including additional legal risks, when compared to domestic transactions. Many assumptions about how to transact business which would be valid in domestic transactions no longer apply. There are major differences of legal approach and jurisprudence between the legal systems of former English colonies, French and Belgian codified systems, Portuguese systems and Roman-Dutch systems, to name just a few of the regimes one encounters in Africa.

All cross-border transactions require input from local counsel and many key provisions of the governing agreements need to be considered in light of their detailed advice. If transactions require the taking of legal security over rights or assets, to name only one example where this matters, a lack of understanding of local features of the legal system can lead to unexpected difficulties: it may not be possible to take security in the manner, or over the kinds of asset classes, that one is accustomed to. The cost of taking security can also be surprising, or indeed a deal-breaker. In Kenya for example, lawyers have recently become subject to a mandatory tariff which obliges them to charge legal fees on a percentage basis calculated on the value of the secured goods. This renders many commodity trade finance transactions uneconomic because of the high cost of taking security in Kenya.

South African banks and businesses are accustomed to seeing penalty clauses in general commercial agreements and finance agreements which impose penalties in default scenarios. Such clauses are generally void in English law-based jurisdictions and if one transacts in English law derived systems one may have to reappraise the agreement in relation to default.

Many of the legal risk-mitigation options available in international contracts are the same, irrespective of the jurisdiction. Choosing one’s counterparty with care is perhaps one of the most important protections available, and knowing one’s client and understanding their business before contracting with them is always worth the time and effort. Structuring transactions in light of the location of realisable assets, e.g. using of offshore accounts where appropriate, ensuring efficient and effective security structures, supplementing structural or credit deficiencies with credible guarantees or collateral, etc. are universally applicable techniques.

In sale or purchase transactions, a thorough legal due diligence process almost always serves to flush out important risks. Negotiating a full set of warranties can also help serve to flush out issues and help to allocate risk appropriately between the parties. It is surprising how often this is overlooked.

One of the most neglected aspects of international transactions is the choice of law and jurisdiction to govern the contract. In some African jurisdictions, public services, including public registries, law courts and enforcement agencies suffer from resourcing constraints and inefficiencies. International arbitral tribunals are a popular and useful way of mitigating unfamiliarity with the court system of foreign jurisdictions. However, even where an arbitral award can be obtained by a claimant, in many instances local enforcement against the assets of the counterparty will still be necessary. Thus the local courts often cannot be bypassed altogether. Fortunately, many countries (including in Africa) have signed international treaties relating to the recognition of foreign arbitral awards, and have enacted arbitration-friendly legislation. However, where this is not the case, enforcement of an arbitral award may be difficult.

Care also needs to be taken in selecting the procedural law that governs the arbitration. Too many lawyers are unaware that specifying in a contract that the legal place (or seat) of arbitration shall be in a particular country has the effect of incorporating that country’s procedural rules relating to arbitration, irrespective of the applicable arbitral rules. Unless the selected country has an arbitration-friendly Arbitration Act, this could spell doom for a cost-effective possibility of enforcing contractual rights.

The legal risk profile of international transactions can be significantly influenced by lawyers with international experience, and no serious international player can afford to proceed without the advice of legal counsel. Larger institutions would do well to heed the often repeated cry from frustrated in-house lawyers, asking that lawyers be involved from the outset of the transaction and to help plan and structure it: it is time and money well spent.

Norton Rose South Africa (incorporated as Deneys Reitz Inc) joined Norton Rose Group on 1 June 2011.