Trojan Horse In Your Investee’s Cap Table?  Venture Capital Advisory On Corrupt PEP Shareholders

Introduction

Politically Exposed Persons (PEPs) present a significant and yet – mostly overlooked risk to investments made by investment fund managers and other investors. While PEP status does not predict criminality, in Africa, it often presents a distinct and further risk to investments due to the associations with corruption and other economic crimes.

Recently, there have been African continent-wide enactments of Proceeds’ of Crime, Anti- Money Laundering and Anti- Corruption and Economic Crimes statutes; all of which inter alia provide the legal basis for civil forfeiture of proceeds of crime (in both criminal and civil suits) and  the establishment of  asset forfeiture agencies in these jurisdictions; and investors and investees should exercise further diligence with regard to PEPs on the investee company’s cap table and which goes beyond the routine investor pre-disbursement AML compliance checks.

Legal Risk posed by a PEP Shareholder

This article will focus on Kenya, although the legal principles apply across African jurisdictions that have enacted laws on civil forfeiture of assets derived from corruption and other economic crimes. Under the Proceeds of Crime and Anti-Money Laundering Act (No. 9/2009) of Kenya , illegally acquired wealth is liable to be forfeited for payment to government coffers.

What if the Shareholder holds a Minority Stake?

Certainly, the stake held by the troublesome shareholder determines the extent to which seizure of his assets affects the investee company, but here is the kicker; it’s problematic if the minority stake seized is to be realized/liquidated for the benefit of the government and the investee company is in a negative cash balance position to satisfy such a seizure.

Risk of Civil Forfeiture posed by a Majority Stake?

The risk of forfeiture is significant where the troublesome shareholder has a significant stake; because the assets of the investee company are rendered at risk of seizure if the court finds that the investee company was started or operated using the proceeds of crime.

Generally, in Company Law, there is separation of legal personality of the company from its owners and directors (the ‘corporate veil’), but this line may be blurred in certain cases including when the court issues a confiscation order upon a criminal conviction or forfeiture order in a civil suit.

The reason the law allows the corporate veil to be pierced in forfeiture cases and the property of the investee company to be confiscated – is that there is a legal right against a person in charge of the company ‘the controlling mind’, which exists independently of the company’s involvement, and the separate legal personality of the company will defeat the right or frustrate its enforcement.

The law therefore asks whether the troublesome shareholder is a ‘controlling mind’ in the company. If there is nothing to suggest that he is not: especially where he is a director and a significant shareholder, the court may order the company to preserve or forfeit the investee company’s assets (which are deemed commingled with the troublesome shareholder’s assets).

This opens the door for a sale of the company’s assets to satisfy such an order even though third parties may bring an application to protect their interests in such commingled company property.

Risk Mitigation

There are legal mechanisms that take into account this kind of PEP risk and we are happy to discuss appropriate checks and risk mitigation strategies with you; depending on a risk assessment of the particular conditions and circumstances of the financing provided to investee companies.