Holding Company Risk: Plaintiffs Target Sponsors and Board Directors | Proskauer – The Capital Commitment

As our other Top 10 articles have demonstrated, there is no shortage of risk for private fund sponsors in navigating today’s economic and regulatory environment. Still, they must prioritize the risk that hits closest to home – lawsuits brought by private litigants seeking to lure sponsors, their funds and their board nominees into litigation. These lawsuits most often arise from holding companies and more specifically from sales, business combinations or other events of liquidity or change of control in a fund’s holding company. We’ve seen a dramatic increase in these types of lawsuits over the past few years, and we expect the trend to continue – and likely accelerate.

In our ongoing series, The Holding Company Handbook: A Fund Promoter’s Guide to Risk and Liability, the legal risks arising from the participation of a fund promoter on the board of directors of a holding company present a risk factor for the entire investment structure, including the general partner, the company management, the individual members of the general partner and the management company, and the fund. While a holding company is often the epicenter of litigation, aggressive plaintiff attorneys pursue theories to go beyond the holding company to assert rights against the directors of the company, and in particular directors appointed by private funds as well as the funds themselves and their sponsors. These claims tend to be based on one fundamental theory: control. The greater the control exercised by the sponsor (or sponsoring entities), the greater the risk that a shareholder or employee of the holding company will pursue a theory of wrongdoing against the sponsor (and its affiliates).

The types of disputes that can escalate to director and fund levels are broad. For example, we have handled claims regarding employee compensation, discrimination, ERISA, and WARN. However, some of the most threatening claims for sponsors relate to claims by shareholders of the company following a sale or other material change or control event. Shareholders seeking to block or vacate the action bring suits not only against the company (including derivatives), but also against board members, private fund shareholders and fund sponsors, including for fraud and breaches of fiduciary duty. Fiduciary duty claims can be particularly complex for sponsors and board nominees who have obligations to their investors but who, depending on the circumstances, may also be required to have obligations to others. other shareholders of the company.

We are seeing more and more claims being filed by allegedly aggrieved buyers – or simply out of buyer’s remorse – seeking to evade their closing or post-closing obligations to recover a portion of the purchase price paid. . These claims take many forms, including fraud, breaches of representations and warranties, and indemnification. In considering these possibilities, sponsors and their funds and trustees are well advised to pay close attention to both the sales process and definitive agreements. For example, fund promoters with directorships should consider each specific representation and warranty made, who is deemed to make it, who is responsible for the required knowledge, and who can – and cannot – be held. liable for an alleged violation.

The private equity industry is in its third generation (by some measures) and has experienced extraordinary growth and in doing so has become highly institutionalized, segmented, specialized and competitive. It’s no surprise that the industry’s growth has attracted more litigation and regulatory scrutiny. This trend is not reversing any time soon. But the good news is that every sponsor can take steps to identify and then mitigate the legal and regulatory risks inherent in their business, especially those of portfolio companies. For more information on these and other related topics, please follow our series, The Portfolio Company Playbook: A Fund Sponsor’s Guide to Risks and Liability.

Learn more about our top ten regulatory and litigation risks for private funds in 2022.

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