For the companies covered by Operation “Zadruga”, the problem is not limited to criminal proceedings but in parallel to the proceedings, they face the loss of foreign clients, sanctions imposed by international creditors and termination of loan agreements by commercial banks in the country
The public in BiH was surprised by the arrests of representatives of over 500 domestic companies, carried out by the police and prosecutors in mid-February 2018 on suspicion of money laundering. The arrest operation raised the great interest of the business community but also triggered all sorts of speculation about the background, depth and consequences on the market. The arrestees, who may face confirmation of indictments against them and even criminal convictions, can, in cooperation with their defense lawyers, identify rather precisely the many legal consequences within a rather broad spectrum of possible punishments, ranging from fines, to suspended sentences, to prison sentences. However, the big unknown in BiH refers to repercussions of Operation “Zadruga” for future business operations of the companies as actions taken by the relevant authorities will cause a chain reaction from their clients abroad as well as from international and domestic creditors, etc.
Under the BiH Criminal Code, “Everyone charged with a criminal offense shall be presumed innocent until proved guilty by a final and binding court decision”. This well-known presumption of innocence - no one is guilty until proven otherwise – is still valid, of course, primarily in legal terms. However, things have rather changed in the world of modern international ( and increasingly domestic) business as international regulations require that business cooperation be terminated or become limited as a result of suspicion, that is, international companies do not wait for final and binding court decisions, unlike the presumption of innocence principle of the criminal law.
In short, if a company is under investigation particularly in relation to the offenses which fall under prohibited business practices, such as various forms of fraud, corruption, money laundering, tax evasion, etc. international companies and banks do not wait for the outcome of the investigation but attach the red flag of risk to the name of such company. Regardless of whether or not the company will be found guilty at the end of a court proceeding, the sheer fact that it is under investigation and that it may be found guilty turns on a red alert in the modern business world as a warning of a risky business partner. It is about risk assessment or so-called risk indexing, not offense indexing. The reasons for such an approach lie in the strict international regulations (even in the domestic regulation, which will be discussed in more detail in the next text) which does not tolerate not only even minor forms of fraud, money laundering, corruption or similar practices – including those with cross-border element – but also establishment of business relations with a risky partner that is not under inves
tigation or is not found guilty at the moment of conclusion of a business contract. There have been the numerous economic crime cases in our country, but Operation “Zadruga” has been the largest ever, involving hundreds of domestic companies, thus making them the red flag bearers. The consequences of the “red flag” are different, and we shall summarize the experiences of the companies operating in our market or the experiences that they will face soon, according to indications or announcements.
1. Risk of losing a foreign client abroad and also in BiH
Developed countries of the West (particularly US, the Great Britain, Switzerland, and EU) have extremely rigorous regulations in place and impose enormous fines for prohibited business practices of their companies, even cross-border practices, as we said above, and even for bad practices of local companies from BiH that international companies cooperate with. Such laws as FCPA in the US (prohibiting cross-border corrupt practices) or the Anti-Bribery Act in the UK and a series of laws against money laundering, strictly prohibit their national companies from running business with risky companies in other countries of the world. For example, if a foreign western company is buying products or services from a company in BiH covered by Operation “Zadruga”, its transactions with such a BiH company may be considered as involvement in money laundering and support to unlawful activities, the practice which is severely punished by a regulator in such a company’s country, which represents an unacceptable risk.
2. Risk of termination of business cooperation with international companies in BiH – unreliable “third party”
In accordance with the above-explained risk of punishment that exists for international companies cooperating with the companies in BiH, almost all such companies carry out mandatory assessment of their local partners, suppliers, distributors and other associates, the so-called third party due diligence. Apart from the financial aspect of reliability of the partner that is subject to due diligence, also due diligence of reputational risk of the business relationship with the partner is mandatorily conducted. Operation “Zadruga” provoked an avalanche of media reports providing a list of all companies, even the numerous individuals representing those companies, thereby leaving an indelible trace on the internet search engines as one of the basic tools for the assessment of reputational risk within due diligence. It is interesting that the red flag can be raised about a legal entity and an individual in the legal entity and also about related legal entities and individuals. For example, if the owner of a company is indexed as risky, the red flag will refer to all of that owner’s companies and related legal entities.
3. Risk of sanctions that may be enforced by international creditors (the World Bank, EBRD, etc.)
It is not unknown for some companies in our country and the region to be under sanctions over many years, imposed on them by international creditors, such as the World Bank, and for not being able for years to bid for contracts funded by such international creditors. It is extremely important to mention that debarment actions of one international financial institution may have a chain reaction and be enforced on entities by all other major international creditors (cross debarment). It is about creditors which fund all important infrastructure investments here, like the investment in the construction of road infrastructure, etc. The irregularities done by debarred companies, which caused the enforcement of debarment action by international creditors, oftentimes seem irrelevant – sometimes it is about two companies owned by the same owner bidding for a contract – and represent almost a routine business practice, although an unforgivable practice in terms of standards of international financial institutions. Money laundering, among other offences, that the companies covered by Operation “Zadruga” are suspected of, is a “serious offense” which can hardly fall off the radar of international creditors. Apart from Operation “Zadruga”, in the context of this risk, is also interesting the arrest of the director of the Road Directorate of the Sarajevo Canton over suspicion (and his subsequent admission) that he took 3% of the value of the contracts awarded for road construction and maintenance. The companies which paid the bribe – which is also an absolutely unacceptable practice – will come under the radar of international creditors and be subject to their debarment action.
4. Risk of suspension of a loan approval process by commercial banks in the country
The current problem, which may affect the companies covered by Operation “Zadruga” and have unforeseeable consequences for their operations, also concerns suspension of the loan approval process and termination of the present loan arrangements by the commercial banks in BiH (and abroad). Banks are under pressure not only of high control standards of their mother banks abroad but also of the domestic regulations, particularly of the BiH Law on Prevention of Money Laundering and Financing of Terrorist Activities and the new tightened entity-level laws on banks. Money laundering and similar unlawful practices raise the red flag high as an indication of risk attached to the loan beneficiary or applicant. Following Operation “Zadruga”, the banks are simply brought into a situation in which they need to assess the risk far more carefully and weigh the risk far more heavily before approving a loan to those companies.
According to unofficial talk in the banking circles, it does not necessarily mean that they will not be able to benefit from anything (loans or other bank products) but the banks will certainly mark them as a potentially high risk and deal with them carefully (as the so-called AML, Anti-Money Laundering, the function of the prevention of money laundering in banks, is part of the credit risk) and will have to include the Zadruga case in their overall risk assessment related to those clients – because banks always collect such information within their risk assessment process. Even when no charges are pressed and when an authority carrying out financial investigations enquires about a client, the banks immediately put clients into a high risk segment. Because each piece of information which may indicate a ground for suspicion may not be ignored. The possible approval of loan applications will require detailed elaboration by banks in case of controls by the relevant regulators. If any of those companies is already a bank’s client, it will always be put on the bank’s watch list. At best, loans will be approved under far tighter protection mechanism (which are less favorable for the applicants, like “more expensive money”, additional protection clauses, etc.) in a loan agreement. Apart from an administrative financial risk (as is the case with third party due diligence), banks assess also their reputational risk in case of cooperation with such companies. A particular risk for the banks is their getting a bad reputation, like the reputation of a bank with a poor AML - the system which may come into play when the bank wants to borrow money from major international financial institutions like EBRD, KfV etc. or to get a capital injection and also in its relations with correspondent banks.
5. Risk of sanctions against whole export industries
It has already happened in BiH that unethical practices trigger sanctions which affect not only the main culprit but also entire industries. Fraud in export of meat to Turkey and apples to Russia – the fraud cases in which some companies repacked imported goods instead of packing BiH products under the contracts – resulted in suspension of entire export arrangements of not only the companies which were directly involved in fraudulent practices but of all other producers which export meat and apples and caused millions-worth loss to the state. These two cases, meat and apple cases, escalated, but after Operation “Zadruga” it can be expected that also other exporting industries covered by the operation will be heavily scrutinized by importing countries, specifically the US, UK, Switzerland and the whole European Union.
How companies protect themselves against the reputational risk caused by judicial processes
The systemic protection against prohibited business practices and consequently against draconian fines issued by regulators and against other consequences which we partially explained above is enforced by the companies through compliance program which has become an international standard in control of managing risks of prohibited practices. With this program, companies instill confidence in all of their business partners in regard to such an internal control system that reduces the possibility of prohibited practices to the minimum. It is also mandatory to appoint a trained person to manage the program (Compliance Officer) along with serious support from the management and its continuous oversight of the program.
Such a program has multiple positive effects: it strengthens the guarantee for the company itself that it will get into prohibited practices, and provides it with a better internal control; reduces creditors’ suspicion over the client’s reliability, while a foreign client reduces its own risk of being under investigation in its own country in relation to a supplier in Bosnia and Herzegovina, while a regulator takes the existence of such a mechanism as an alleviating circumstance in its inspection and even in case of imposing a fine or other sanctions.
To be continued…
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