Private equity executives expect personal action against them as directors to increase, with 44 per cent foreseeing more actions over the next three years, and 32 per cent feeling an increase may be likely.
“There is a regulatory pendulum that swings from one extreme to the other. In addition, if you look at the litigious society that exists in the US, you have to believe that trend will eventually make its way over here, though we have yet to see it within our business or our portfolio,” says Charles Ind at Bowmark Capital.
Some see an increase in actions as inevitable in the light of increasing regulation against business, both at the European and national level. “It is all around the revisions to the Companies Act, which started the train, and the latest thing is the Bribery Act,” says Wol Kolade, managing partner at Isis Equity Partners. “In the past you could isolate things at the portfolio company level, but now they are moving up to the fund as the controlling shareholder – there are many things within the Companies Act that hit you because you are the controlling shareholder. Action against directors will increase as people become more aware that there are a lot of avenues to create mischief.”
“There is an increasing focus on regulation and legislation, whether it is fulfilling carbon obligations, health and safety, or keeping a copy of your loan notes,” says one UK mid-market professional. “In private equity we have had two years of talk and over the next three years we are likely to see a little bit more implementation.”
Eight per cent of respondents were concerned about personal litigation at the fund level. However, 40 per cent are concerned at the portfolio company level, and 20 per cent make no distinction.
“I’m more concerned about personal litigation at the portfolio level simply because we have such a robust corporate governance and risk process that if someone is going to take some action it would be most likely as a consequence of activity in the portfolio, and that is where you might argue defences are weakest – partly because you are further removed and partly because their D&O policies aren’t as good as ours,” says a risk manager. GMT’s Tim Green agrees: “We have total control over the fund but not necessarily over all aspects of a portfolio company’s operations. As the board member of a portfolio company you can mitigate to the greatest degree possible any potential liability by due care and attention as a director, but ultimately something may happen that could give rise to a potential liability. At the fund level that is totally different. It’s not just that we sit on the board of the fund – we are the fund.”
While the FSA is regarded as having done a better job of promoting its enforcement actions, anecdotal and actual evidence appear to tell a different story. “Everything you hear tells you that personal action against directors is increasing. You talk about it at the football, but I personally have seen no evidence for it,” says Dennis Hall, portfolio director at Baird Capital Partners Europe. “At the portfolio level we have good systems and controls in place and proper D&O cover, so I am not concerned about personal litigation. What does concern me are investment returns from my portfolio companies. They are the driver of our business and all the other risks are manageable.”
Investment returns at portfolio companies are the key concern for 84 per cent of respondents, with 12 per cent concerned by personal litigation. “Investment returns are a concern. Ultimately, if I don’t deliver investment returns then I don’t raise another fund. It is binary,” says Green.
Daniel Max, head of Marsh’s private equity and M&A practice in the UK, comments: “From our experience in structuring D&O programmes for a wide variety of private equity-backed companies, it is clear that D&O exposures at a portfolio level tend to be different to that of a ‘traditional’ company. This is borne out in the types of claims that we typically see. It is vital that a portfolio company’s D&O policy is specifically designed to address the nuances of private equity ownership and ensure that those at a fund level are adequately protected. Investment directors should view the portfolio company D&O policy as their first line of defence with regard to any personal liabilities at portfolio level. This will complement the additional protection provided at fund level through insurance or indemnification.”
Over the following weeks, Real Deals will talk to more people at the coalface to discover where GPs see their greatest threat coming from. To express your interest in taking part, email firstname.lastname@example.org with the subject heading “Risk Survey”.