17 June 2016

New liability risks for private equity investors?

As responsible investors, private equity firms are well aware of the need to ensure that their portfolio companies behave properly: thorough due diligence, rigorous compliance procedures and extensive ongoing oversight are commonplace, and generally ensure that investee companies comply with all relevant laws and best practices. However, the extent of a shareholder's liability for infringements that it was powerless to prevent – despite its best efforts – has been the subject of much discussion among financial investors in recent years, with concerns about pension fund liabilities in the US and anti-trust fines in Europe high on the agenda. And, as regulators increasingly target business owners to secure compliance by the underlying business, the pressure on active investors will only increase.

Anti-corruption rules and transparency standards are in the spotlight at the moment, particularly following a summit held in London last month, convened by the British prime minister and held in the shadow of the "Panama Papers" scandal. Despite some unfortunate unguarded remarks made to the Queen, the summit was hailed as a success, bringing together an unprecedented combination of governments, businesses, and domestic and international organisations, including the European Commission, the IMF and the World Bank. At the same time, perhaps in order to show that it wanted to lead by example, the UK government announced a renewed intention to introduce a new corporate offence of "failure to prevent economic crime".   

As is well known to funds investing in British companies, the UK's Bribery Act currently includes a similar strict liability offence of "failure to prevent bribery", and a proposed new offence of "failure to prevent the facilitation of tax evasion" is also under active consideration in Britain. However, it is expected that the new "failure to prevent economic crime" offence, if enacted, would reach further than bribery and tax evasion, and would probably include liability for those who fail to prevent fraud, theft, and false accounting, amongst other offences – as well as having significant extra-territorial effect. Strict liability means that a company would be liable for the offence whether or not it knew about the wrongdoing (which could be committed by a third party over which it has little or no control). The consequent burden on compliance functions and the due diligence process is likely to be onerous. 

If these new offences make it on to the statute books, the crucial questions will be: who is responsible for preventing the crimes; what is a reasonable level of enquiry and due diligence; and what defences will be available to those who have done all they can to try to prevent a crime being committed, but have failed. Non-executive directors, including those nominated by private equity investors, are likely to be in the firing line, given the extended scope of senior officer liability in this area, and commercial organisations may also be held responsible for the acts of their "associated persons", following the UK Bribery Act's model. Whether a shareholder is associated with its investee company will be a question of fact, but the general view is that merely owning a significant or majority shareholding, without more, is not sufficient to create liability.  

Drawing parallels with the UK Bribery Act, it may be a defence to the "failure to prevent economic crime" offence to demonstrate that a commercial organisation has adequate procedures in place to prevent economic crime taking place. Accordingly, it is very important for any director to ensure that proper steps are taken at the level of each company in the group (irrespective of whether the director sits on the board of such companies).

These initiatives are certainly not confined to the UK (for example, click here for a summary of recent changes in France), and it is clear that it is more important than ever to ensure that appropriate procedures are put in place by the boards of portfolio companies in all countries to prevent infringements of those laws which are regarded as sufficiently serious to impute liability beyond the company itself. Indeed, we are advising a number of firms who are working with portfolio company boards to ensure that compliance levels are robust, and that they remain so. 

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