Parts of the UK’s Companies Act 2006 that will come into operation on October 1 will mean that investment directors put in place as part of a private equity buyout will be in breach of the
Parts of the UK’s Companies Act 2006 that will come into operation on October 1 will mean that investment directors put in place as part of a private equity buyout will be in breach of their duties, according to law firm Eversheds, which says that unless directors take certain simple steps their ability to exercise step-in rights may be affected.
The firm says the changes to the rules mean that all directors have a duty under the Companies Act 2006 to avoid actual or potential conflicts of interest. Directors must henceforth proactively avoid conflicts of interest and not just plan to manage the issue as they currently do.
The major concern for private equity firms is that this could effectively lead to the loss of step-in rights that allow them to take control of a portfolio company at board level if the investment starts to go wrong.
‘In the current difficult economic situation, private equity investment directors may need to step in and take control of an investee company at board level,’ says Will Sharpe, a private equity partner at Eversheds, which works with 22 private equity firms that focus on mid-market deals.
‘However, with the change being brought in under the Companies Act 2006, if the director has a conflict of interest, which for an investment director who owes duties to the investors in the fund is highly likely, the board of the company or its shareholders must authorise that conflict.
‘If this is not done, and a management team refuses to authorise an investor director’s conflict either for a new investor director or the existing one, that director cannot continue to act or exercise step-in rights without the risk of incurring personal liability.’
Sharpe notes that the new legislation allows a company’s board to authorise a conflict as long as the director in question, or any other director who is also conflicted, does not vote on the authorisation resolution. For companies incorporated before October 1, a shareholders’ resolution must also have been passed to give the board this authority, something that should be done before October 1.
‘This is potentially a very serious issue which needs to be looked at as soon as possible,’ Sharpe says. ‘It does have a simple solution but equity documents for existing investments need to be amended to include a requirement for the management teams to authorise any conflict of an investor director, with suitable mechanisms built in to ensure that this will happen. If this does not, private equity houses may find that the ability to direct and manage their investments has been compromised.’
