Representation and Warranty Insurance (RWI) is an increasingly important tool for managing transactional risk in technology-sector M&A. In the second of a three-part series, we look at trade law and international sanctions. Two risks in this area of law, which can involve criminal penalties, have been highlighted in recent transactions involving technology companies.

Elevated risks for cryptology products

The target company's risk profile in trade law/sanctions compliance is higher where:

• its product offerings include cryptology, and
• such technology or goods have been transferred outside the target's home jurisdiction.

The nature of the workforce for technology companies tends to be mobile and not necessarily dependent on the location of the target's head office. As a result, development teams may be physically located in another jurisdiction altogether or be composed of team members located in various jurisdictions. Customers also tend to be located in many jurisdictions.

A policy that demonstrates an acknowledgement of compliance issues related to accessing and transferring such cryptology goods or technology (and other controlled goods or technology) outside the target's home jurisdiction and any process implemented to address this type of risk may (depending on effectiveness) go a long way to providing comfort to both the purchaser and the RWI insurer in a M&A transaction. Inadvertent disclosures without consideration of such compliance issues, or even an evident failure to consider these issues when asked in the diligence process, may result in exclusions or limitations from RWI coverage and lead to negotiations between the seller and purchaser to allocate such risk, by way of a creation of a separate indemnity to be provided by the seller.

Economic Sanctions Violation Risks

Sales to (and investments by) foreign entities and nationals is another potentially problematic area on which technology companies may not always be focused. This tends to be especially true in the startup phase when companies are initially focused on raising capital and growth. As they approach the exit stage, targets should be prepared for the fact that the purchaser's diligence may include investigating compliance with Canadian economic sanctions laws, including under the:

• Special Economic Measures Act;
• United Nations Act;
• Freezing Assets of Corrupt Foreign Officials Act;
• Sergei Magnitsky Law; and
• Criminal Code (anti-terrorism provisions).

Purchasers will be seeking to ensure that sales by the target business and investments in the business do not involve entities sanctioned under such legislation.

As is the case with violations of export compliance laws in respect of cryptology, it is difficult in a typical transaction timeline to accurately quantify the damages that may arise in addition to potential imposition of fines for violating the laws listed above. Internal investigation and reporting costs can be very high. As a result, RWI insurers are often unwilling to assume these risks.