Tuesday, January 03, 2006

Grading international business transactions exams - here are two of the questions

I'm slogging my way through 97 final exams in international business transactions. I tried something different this year and drafted facts that were both more political and more international development than what I usually do. But much of my pro bono work is in the area of international development finance, so I thought I would draw on some of that, while simplifying radically to fit within exam time limits. Here are the two main questions - students seemed to handle them fairly well, in a three hour exam setting. Still, it may have been too long to read - I'll have to think about this for next year. (Actually, having graded a bunch of exams now, I think maybe it is too easy - provided too many signals for structuring. Hmm.)

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Question 2: 60%

The small West African state of M had been in civil war for over twenty years, with many dead and widespread destruction. Five years ago, a peace was brokered by the UN, which took over M as a UN protectorate and began rebuilding operations. Those operations have gone relatively well, and at the beginning of 2005, national elections were held as the first step to ending the UN protectorate and reestablishing full state status of M. The winner of the elections was Madame Renee Char, the first woman head of state in Africa and, as she points out, much more relevant to her current task, a Harvard trained economist. You are an American citizen, born in the US to parents who fled M in the fighting - you grew up and trained as a Wall Street international transactions lawyer. You were persuaded by Madame Char to leave your lucrative New York practice, however, to be her chief lawyer in the economic rebuilding process for M. You have never actually lived in M, and are wondering just what you have let yourself in for, joining her team. As your initial task, Madame Char has assigned you to prepare in important internal legal memorandum setting out the international business transactional arrangements for re-starting foreign investment in the economy of M.

The only significant asset at this point in M that is capable of gaining hard currency export earnings is diamonds. The country has significant diamond mines that were an important aspect of the civil war – the conflict diamonds were fought over by all sides in the war. The mines are now working at only a fraction of their potential, and getting miners back to work is critical for the employment situation of the country as well as to provide a means of foreign exchange earnings. It is estimated that restoring the existing diamond fields to optimal production would require an investment of $40 million over a two year period, in addition to an assurance that political stability would be maintained. In addition, there are new diamond fields that could be opened up by means of very sizable foreign investment in the form of project finance over a five year period, requiring some $500 million. Needless to say, such amounts for investment do not exist inside M – although there are some very wealthy individuals, both inside M and living abroad, their money is kept abroad and some of it is probably questionable in origin. Despite that, one of Madame Char’s goals is to attract at least part of those several billions of dollars of M nationals back to M as investment. In addition, she looks to international investors to put in most of the investment funds for the diamond mines, both the renewal of the old fields and the development of new ones, if she, with your assistance, can structure the right kind of deal.

You are currently in discussions with two foreign mining companies – one in Canada and one in South Africa – to see if they are interested, either separately or perhaps together, in investing in the existing fields. The Canadian company has expressed an interest in investing a larger amount, perhaps $20 million, in the existing fields. It does not want an active management role in the fields, but instead seeks some kind of preferential or exclusive arrangement to purchase the diamonds at a fixed and favorable price, rather than having them pass directly onto the international commodities markets. The South African company is perhaps willing to put in something between $5 and 10 million, but is interested in managing the project, using its South African expertise. The mines are currently owned by a State Company, M Diamonds Inc., whose stock is wholly owned by the State of M. For political reasons, the state of M is unwilling to privatize its M Diamonds Inc by selling its stock directly to investors, but it is willing to enter into contractual arrangements with investors that would give investors control of the existing fields. You are also in discussions with two wealthy M nationals who live in Paris – you believe that they could be persuaded to invest up to $10 million, as passive investors who did not participate in management, if the financial rate of return were high enough.

All the possible investors have two significant risk concerns, beyond the financial arrangements and rates of return. The first is exit strategy – will there be any political blockages in taking capital and post-tax profits out of M? You have offered a written guarantee of the State Bank of M, M’s central bank, that capital and profits may be repatriated abroad, but have doubts that this will satisfy foreign investors. The second is physical security – will the refurbished diamond mines be safe, or could they be subject to militias, short of restarting the civil war, but enough to seize the mines, take hostages, etc. You are in conversations with Madame Char, UN Security Council representatives, and the principals of a South African security firm, Mercs Inc., which provides commando forces drawn from former South African security forces and ex-ANC soldiers, which have proposed to provide security for the mines. The UN Security Council representatives strongly favor the idea – and indeed are willing to pay the sizable immediate down payment on the commando forces, with on-going costs to be financed out of diamond revenues – but you, the consummate Wall Street lawyer, are wondering how you write that into an enforceable contract.

Madame Char has asked you to draft a private memorandum proposing an investment strategy that in your view is most likely to secure the necessary foreign investment to restart the mines and provide necessary security and cover the concerns raised with respect to the various parties above. It should reflect both business planning concerns as well as explain the legal documentation required to make the proposed transaction work. Please draft that memorandum, in a well organized fashion.

Question 3 (30%).

Same facts as above.

Madame Char has asked you to take up a second issue. This is how to develop the brand new diamond fields. The investment involved here is very large, at least in M - $500 million. Again, for political reasons, Madame Char has rejected the idea of 100% foreign ownership of a company set up to develop the new fields. She has said that 49% ownership of a new company by foreign investors would be acceptable, but would prefer that the bulk of the investment funds required come from loans. To that end, you have been in meetings with foreign banks in Paris, seeking to find a way to structure loans. By managing to seize through Swiss courts the accounts of a previous dictator of M, you now have $150 million in Swiss accounts. You are willing to pledge that amount as collateral in structuring a transaction with a group of banks, who are willing at least in principle to treat the $150 million as sufficient collateral against an aggregate loan of $500. If the loan can be structured so as to satisfy their desires to reduce the risks of having $500 million outstanding all at once in the early years of the project, and to hold down costs of capital for M, then you think there might be a possible deal. Draft a memorandum to Madam Char describing the transaction, from both a business and legal standpoint.

3 comments:

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