Successful private equity sponsors are often actively involved in the management of their portfolio companies. That involvement, which may include holding a majority of the board seats, providing financial analysis and modeling support, dictating the capital structure and setting business strategies, can be important to the sponsor’s ability to realize on its investment. That same involvement, however, can expose the private equity sponsor to risk in the event the portfolio company underperforms and becomes distressed. Private equity sponsors dealing with a distressed or troubled portfolio company should be conscious of the risks in dealing with their portfolio companies and employ risk mitigation strategies where appropriate.
Those risks include personal liability for officers and directors for certain actions taken by the officers or directors, including, but not limited to, improperly obtaining personal benefits, actions taken in bad faith, intentional misconduct, or acting in a grossly negligent manner. In addition to personal liability for the officers and directors, the private equity sponsor may incur liability if a plaintiff is able to successfully overcome the presumption of separateness with respect to the corporate entities. While the elements of piercing the corporate veil vary by jurisdiction, as a general rule, the private equity sponsor may incur liability if the sponsor exercised complete domination and control over the portfolio company and used that control to circumvent a statute, commit fraud or perpetuate an inequity.
