Fund sponsors typically obtain a variety of rights in connection with their investment in a portfolio company. These include liquidation preferences, director appointment rights, and enhanced voting rights. If the portfolio company experiences financial difficulties or if disputes or other liability issues arise, these rights can create complex conflicts of interest issues for the fund sponsor and its affiliates who may be fiduciaries of the portfolio company.
A Proskauer blog discusses some of the situations in which conflicts may arise and provides some practical advice on how to mitigate their risks. Here’s an excerpt:
First and foremost, sponsors should ensure that their board designees are sensitized to each of the duties they owe and to whom. While board members may owe duties of loyalty and care to the company, and potentially others, the duties they may owe to the fund and its investors can differ depending on, among other things, how the fund is structured, which jurisdiction’s law applies, and what is provided for (or disclaimed) in each entity’s organizational documents.
Likewise, sponsors and their board designees should be on the lookout for any possible apparent conflict between the interests of the fund and the portfolio company. In cases of potential conflict, fund personnel should consult with counsel and coordinate with the company as necessary to ensure that procedures are implemented to protect against any argument of perceived or actual conflict tainting an otherwise beneficial transaction or board decision.
The blog points out that these protective procedures “may include the formation of a special committee to evaluate a potential transaction, consultation with minority shareholder groups, and obtaining independent valuations.”
-John Jenkins, DealLawyers.com March 12, 2021