By Huw Thomas
The global regulatory environment has become increasingly challenging for private equity in recent years. In our view, this trend will continue as politicians in the UK and elsewhere seek new tools to hold business accountable.
A key principle of English law is that the liability of a shareholder in a limited company is restricted to the value of the shareholder’s investment. The circumstances in which the courts will override that principal (referred to as “piercing the corporate veil”) are limited. However, we are seeing increasing instances where the veil of incorporation, instead of being pierced, is being side stepped by legislation or court judgments that impose liability directly on parent undertakings for the acts of their subsidiaries.
Limited Liability — An Assault on Multiple Fronts
The risk of imposition of liability on private equity firms is particularly acute when a portfolio company has engaged in criminal behaviour such as cartel activity, bribery, corruption, money laundering or tax evasion. In these cases, statute may or is likely in the future to apportion liability to a controlling shareholder. For example, a parent undertaking may be held liable for failing to prevent bribery or corruption by its subsidiaries. In 2014, the European Commission fined a private equity investor €37 million in respect of cartel offences committed by its portfolio company. There are also special cases, such as pension liabilities, where statute (or political/media pressure) may result in liability for a controlling private equity fund.
The imposition of liability is also increasingly seen in the areas of environmental and health and safety liabilities where tortious claims are being brought against UK parent undertakings. Royal Dutch Shell successfully defended a recent and widely publicised claim brought by two Nigerian communities regarding environmental pollution allegedly caused by a Nigerian subsidiary. However, in other cases, the courts have acknowledged that a controlling shareholder could assume responsibility for subsidiary actions in certain circumstances (e.g., in relation to a successful claim involving asbestos exposure).
Protecting the House — What Should Deal Teams Be Alert To?
Faced with this changing liability landscape, private equity firms cannot consider themselves as purely financial investors, immune from liability for claims against portfolio companies. Firms need to be alert when dealing with businesses that operate in higher-risk jurisdictions or industries, or which may have a greater exposure to environmental or health and safety claims. In addition, there are likely to be statutory and historic liabilities that cannot be negated so the importance of proper diligence cannot be understated. Group structure, corporate governance arrangements, procurement of “central services”, policies, procedures, training and monitoring should all be areas of focus. In our view, firms must also be alert to wording in deal documents such as a “group supervision clause”, which states that the “main operating board” (including appointees of the buyout firm) is responsible for key management decisions, as these may be seized upon by potential claimants.
Private equity firms, like other business owners, are in a difficult position. They are expected to walk an increasingly fine line between demonstrating sufficient oversight of their portfolio companies and not exercising so much control that they open themselves up to claims of assumed responsibility for portfolio companies’ actions.