Businesses today are facing new challenges. The COVID-19 pandemic is obviously having a major impact on the global economy, which means that many businesses, including portfolio companies held by private equity firms, are focused on the short term, with maintaining liquidity and adequate levels of working capital as their main priority. Other issues on the radar include supply chain management and keeping pace with rapid market developments, preferably remaining a few steps ahead of the competition, having regard in particular to the gradual lifting of lockdown restrictions.
As indicated in an earlier blog post in this series, the current crisis should not, however, be used as an excuse to throw regulatory boundaries overboard.
Cognizant of the trend that, in the long run, private equity players will continue to attract social and political attention, including from the authorities, we would like to address the antitrust parental liability risks for private equity sponsors. More concretely, on several occasions, the Dutch Authority for Consumers and Markets ("ACM") and the European Commission have held a private equity sponsor liable at fund level for an antitrust infringement committed by one of its portfolio companies.
At least one of these decisions was upheld in the final instance by the Dutch Trade and Industry Appeals Tribunal. The General Court of the European Union has also confirmed the applicability of the parental liability doctrine to private equity sponsors, in for example the Goldman Sachs case. According to these rulings, private equity sponsors may be fined if their portfolio companies do not act in accordance with applicable competition laws, thereby exposing the sponsor to claims for damages. This blog post provides advice on how private equity sponsors can mitigate their antitrust risks.
Application of the parental liability doctrine to private equity sponsors
The EU competition rules apply to ‘undertakings’, defined as entities or groups that operate as a single economic unit. Thus, if a portfolio company owned by a private equity sponsor infringes the competition rules, both the portfolio company and its sponsor can be held liable for the antitrust violation.
- The competition authorities will consider a private equity sponsor and its portfolio company to constitute a single undertaking if the private equity sponsor has ‘decisive influence’ over the portfolio company. A sponsor is considered to have decisive influence over a portfolio company if the latter could not determine its market conduct independently of its parent at the time of the cartel infringement. In addition, the authorities must demonstrate that the sponsor effectively influenced the portfolio company's general commercial policy. This does not mean, however, that the authorities must prove that the sponsor actually directed the alleged cartel conduct.
- It follows from certain case law that the existence of 'decisive influence' by a parent company, i.e. the sponsor, will be presumed if, at the time of the cartel infringement, the parent company held 100% (or almost 100%) of the subsidiary's shares. In this case, it is presumed that the sponsor could exercise decisive influence over the portfolio company and effectively did so. This presumption is rebuttable, but the sponsor bears the burden of proof.
- It is somewhat easier for a mere financial investor to avoid the threat of parental liability. It must be able to prove that its participation in the portfolio company is limited to an investment for the sole purpose of making a profit, without any involvement in the management of or control over the portfolio company.
Some practical do's and don'ts
As indicated above, sponsors can be fined for competition law infringements committed by their portfolio companies. These fines can be significant and amount to up to 10% of the group's annual worldwide turnover, at the EU level, and up to 40% of the group's annual worldwide turnover in the Netherlands. In calculating their fines, the regulators tend to consider the entire portfolio of companies held by the sponsor to form a group in this regard. Below we provide some practical do's and don'ts to help avoid regulatory difficulties.
- Effective compliance/whistleblower programs should be implemented at the level of both the sponsor and its portfolio companies. These programs should be updated, tested and monitored on a regular basis.
- The abovementioned presumption of decisive influence in the event of close to 100% control may be difficult to avoid in practice. However, careful design of the governance structure, e.g. preferring negative control provisions to positive ones and having sponsor representatives act as board observers rather than effective (supervisory) board members, can help to refute the presumption of decisive influence.
- When selecting potential investments, thorough antitrust due diligence should be conducted.
- Warranties and indemnities, W&I insurance and other contractual provisions in transaction documentation should be tailored to take into account antitrust risks, relating to the period in which the company was part of the sponsor's portfolio, as the sponsor may still be exposed to regulatory risks even after it exits.
- Thorough documentation of the portfolio company's decision-making process is recommended.
- Sponsors can proactively manage the risks associated with their portfolio companies by stipulating, as a standard practice, in the shareholder or investment agreement which party shall bear the risk of fines or claims for damages associated with anticompetitive conduct by the portfolio company.
Further guidance on developments relevant to private equity and venture capital will be provided in upcoming posts in our private equity and venture capital series.