Cross-border M&A in Iceland in the light of Capital Controls

By Baldvin Björn Haraldsson & Einar Baldvin Árnason

Posted: 23rd May 2014 09:09

In the fall of 2008 Iceland suffered a major economic crisis when most of its banking system collapsed within the space of a few weeks.  Since the collapse of the banking system, foreign exchange transactions and cross-border movement of capital have been subject to capital controls, as further outlined below.  Despite the turmoil in the financial sector in Iceland it seems that innovation has thrived and many startup and early stage companies, as well as some of the more established companies, have attracted interest from foreign investors who have been keen to capitalise on the opportunities presented by the current economic situation. 
 
This article gives a very brief and non-exhaustive overview of some of the factors concerning the capital controls which are relevant for foreign investors who are considering making an investment in an Icelandic company. 
 
General issues concerning foreign investment
 
It should be noted that according to Act No. 34/1991 on Foreign Investment in Local Businesses, foreign investment is generally permitted in Iceland, with certain limitations which are stipulated in act.  These restrictions and limitations primarily relate to investment in fisheries and businesses related to natural resources.
 
Furthermore, Iceland forms a part of the internal market of the European Union (EU) through the Agreement on the European Economic Area (the “EEA Agreement”).  The EEA Agreement allows Iceland to participate in the internal market of the EU on the basis of its application of EU law relevant to the internal market.  Relevant EU legislation is incorporated into the EEA Agreement and thus applies throughout the EEA, ensuring the homogeneity of the internal market.  Therefore, as a general principle, Icelandic law concerning cross-border mergers should substantially be in line with relevant EU law on the subject.  Although free movement of capital is a fundamental internal market freedom, Iceland has implemented capital controls on the basis of the provisions of Article 43 of the EEA Agreement.  These controls are discussed briefly below.
 
Capital Controls
 
In November 2008 the Central Bank of Iceland (the “CBI”) used the authority granted to it by the parliament of Iceland to impose restrictions on cross-border movement of capital and foreign exchange transactions in response to the substantial deprecation of the Icelandic Króna (“ISK“) and significant outflow of foreign currency which posed a serious threat to the stability of the foreign exchange market.  The rules on capital controls have now been incorporated into Act no. 87/1992 on Foreign Exchange (the “FX Act”). 
 
The purpose of the rules on capital controls contained in the FX Act is to restrict or to stop, on a temporary basis, certain types of cross-border capital movements and foreign exchange transactions related thereto which, in the opinion of the CBI, cause serious and substantial monetary and exchange rate instability.  Transactions concerning import and export of goods and services are however largely unaffected by the capital controls.  Cross-border movement of capital is defined as the transfer or transport of capital across national borders and transfer or transport of capital between residents and non-residents and which relate to certain types of transactions specified in the FX Act. 
 
Since the implementation of the capital controls, Iceland has introduced a number of measures in order to ease the tight capital controls and thus encourage further foreign investment.  These measures include the “new investment programme” and the “50/50 route”, each of which is discussed briefly below.
 
The New Investment Programme
 
New domestic investments as defined in the FX Act are unrestricted.  The FX Act defines a “new investment” as an investment made after 31 October 2009 for the inflow of foreign currency which is converted into ISK by a financial undertaking in Iceland at the spot-rate.  Inward direct investment in foreign currency is therefore excluded from the definition.  There are also certain restrictions concerning the permissible types of investments and the origin of the capital used for such an investment.  An investor shall, with the assistance of a financial undertaking in Iceland, notify the CBI of the new investment within two weeks from the time when the new inflow of foreign currency is converted into ISK.  The primary benefit of this programme is that if the investor chooses to divest, the funds which are realised by the investor as a result of divesting can be converted into foreign currency and transferred abroad once the CBI has confirmed that the funds in question are in fact the proceeds from the sale of a “new investment”.  In other words, the investor will not be locking in his funds by making the investment in Iceland.  Although not expressly a part of the new investment programme, the CBI has also been prepared to grant exemptions from the capital controls to investors who have made a new investment enabling them to re-domicile Icelandic companies abroad or transfer its assets abroad instead of the investor selling the new investment in Iceland and subsequently transferring foreign currency abroad since, in economic terms, the outcome is comparable. 
 
The 50/50 Route
 
Under the 50/50 route, investors who have been interested in investing in Iceland on a long term basis have been able to participate in currency auctions which have been held by the CBI on a regular basis.  These auctions are still being held but it remains to be seen how many auctions will be held by the CBI.  In a currency auction the CBI offers to purchase foreign currency in exchange for ISK.  In accordance with the terms of the auctions, the investor must retain uninterrupted ownership of the investment, which can be either in the form of treasury bonds or dematerialised shares of a public limited liability company, for at least five years from the date of purchase.  During this period the investment is subject to certain conditions which include that the investor cannot sell or pledge the investment.  However, the benefit from the 50/50 route is that the investor can get a premium amounting to 10-30 per cent on top of the normal spot-rate for the ISK which he acquires.  It should be noted that if the terms of the auction are violated the CBI has the authority to redeem one third of the investment, in which case the CBI reserves full right to initiate legal action, seize assets or take other legal or enforcement measures in order to carry out the redemption. 
 
Recent Transactions in Iceland
 
As stated before, the capital controls and the economic situation in Iceland have not prevented foreign investors from showing great interest in the many investment opportunities currently available in Iceland.  This interest has led to a number of relatively large transactions being completed in recent years despite the unusual and somewhat complex circumstances.  BBA’s strong reputation in M&A transactions has allowed the firm to assist a number of investors to navigate the through these complexities.  BBA has helped these investors determine the optimal deal structure, based on their needs and preferences, and has helped ensure an effective execution of such transactions.  Along the way BBA has further developed a good working relationship with the CBI and possesses a valuable experience in matters concerning acquisitions of Icelandic companies.  Among the transactions BBA has assisted clients are Jive Holding Inc.´s acquisition of Clara ehf., J2 Global´s acquisition of SecureStore, Sabre Holding Inc.´s acquisition of Calidris ehf., and the public takeover of Alfesca by Lur Berri. 
 
Baldvin Björn Haraldsson is one of the founding partners of BBA.  He has extensive experience in M&A, banking & finance, capital markets and commercial and company law.  Baldvin is a qualified attorney both in Iceland and Paris.
 
Recent experience includes:

Baldvin can be contacted by phone on +354 550 0500 or alternatively via email at baldvin@bba.is
 
Einar Baldvin Árnason has been a partner at BBA since 2003.  His practice covers mergers and acquisitions (particularly cross-border), banking and finance, bankruptcy and insolvency and general corporate advisory work. 
 
Recent experience includes:

Einar can be contacted by phone on +354 550 0500 or alternatively via email at einarbaldvin@bba.is

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