“Importance of timely due diligence”

This recent case highlights the importance of all parties conducting thorough due diligence.

The High Court in London issued a judgement last Friday concerning a major gas-related case in Nigeria, and a short overview appeared in the papers over the weekend. I was drawn to read Sir Ross Cranston’s full judgement (available here) as I have both lived/worked in Nigeria and recently been involved in several West African upstream hydrocarbon projects.

Reading the article in the Financial Times on Saturday 5 September, one could be forgiven for dismissing this as just another case of corruption in a hydrocarbon-rich country. The case is a complex one and this judgement is just the latest step in its resolution; a process which has so far taken several years.

A more careful reading of the full judgement yields a number of lessons for any company wishing to do business in remote markets, as well as for the governments wishing to attract bona fide foreign investors. None of these lessons is either new or in any way surprising, but given the disclosures about the course of events in this case, is clearly worth repeating:

From the government’s perspective, it is essential that one of the early steps in any potential investment relationship is to conduct thorough due diligence on the counter-party. This means not only its corporate structure and history, but the background of its key decision makers; their business history and ability to perform their obligations under any future contract. In this case, there seems to have been little such diligence undertaken, at least until 8 years after the contract was signed; and then perhaps only when prodded by the eye-watering settlement of the initial arbitration hearings in London.

The structure of control in the Petroleum Ministry or appropriate authority should make it absolutely clear whose responsibility it is to undertake these investigations, at what point in the contract process they should be carried out and what areas they should as a minimum cover. This is by no means a way to detect fraud, but may well raise certain “red flags” that are worthy of further investigation, at an early stage of engagement. The rather belated due diligence carried out in this case certainly revealed a whole display of such flags, any one of which could have raised the suspicions of the authorities had it been undertaken early on.

From the investing company’s perspective (and leaving aside the prima facie evidence for fraud which the judge concludes is present here), one of the basic tasks before any new country entry is a thorough review of the legal and commercial framework in the country; not only as it exists on paper, but also ideally as it is practised. On top of this, a good understanding of the process of project approvals, the stakeholders concerned and the likely time required to jump over all of the administrative hurdles. Finally, a reasonable assessment of the risks involved in operating in the country and/or landing the particular project. Homework like this costs time and money, but this effort pales into insignificance when compared to the legal and commercial unravelling of any subsequent problems.

It is encouraging in this case that the Nigerian government has decided to pursue both its challenge to the sizeable arbitration award and the fraudsters themselves.

Leaving the circumstances surrounding this particular case and moving to more general trends. In the current global situation of potential peak demand for oil, the governments of African and Middle Eastern countries are realising there is an increasing risk that hydrocarbons not produced in the next 20 – 30 years may well remain in the ground. This would benefit neither the government nor particularly their people who rely on the tax receipts of hydrocarbon developments to provide any sort of infrastructure to drive domestic or social progress.

Cases such as this are a wake-up call to both governments and to potential investors in Africa and elsewhere that now is the time to do your homework and get long-lasting, equitable, deals in place in the sector, while there is still adequate global demand over the lifetime of the project.

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