Divesting distress

Almost two years on from the emergence of the sub-prime black hole that precipitated the credit crisis, concerns over boom vintage investments appear to be reaching something of a crescendo. The most troubled private equity houses are selling for their lives. Candover recently completed the £553m sale of energy consultancy Wood Mackenzie to Charterhouse Capital Partners, while 3i is currently finalising the sale of its entire venture portfolio. Other firms are expected to follow suit and begin offloading some of their most difficult assets in the coming months.

However, rather than providing a quick solution, a hastily-arranged sale could spark a new set of legal difficulties - in France at least. A recent case has revealed a renewed focus by French courts on seller liability post-closing, which challenges the notion of an exit representing the finality of an investment. This, in turn, could change the way houses approach a sales process, suggesting further implications for those that had been expecting a glut of bargains to come to market in the near future.

Shareholder liability

The notion that a disposal does not always represent the end of the story for owners is actually a long-standing principle in French law. "There is a law called the 'action for clearance of liabilities', which states that the judicial administrator can act against the previous management of an insolvent business if they are deemed responsible for mismanagement acts having generated a deficiency of assets," explains Olivia Gueguen, partner in Dechert's Paris office. Notably, this action applies not only to the management of the business, but also to the "de jure" manager - the parent company, for example.

Interpretation of this principle has now be altered as a result of a recent court ruling, in which a private equity firm was held liable to pay damages to the employees of a portfolio company that it had put into liquidation. Though this case did not involve a sold entity, it does highlight two important trends that are likely to be influential to how the law is applied. Firstly, a new recourse has been opened to employees of a failed business to directly litigate against their former employers, and secondly, there is a tendency to engage the liability of shareholders as "de jure" managers.

That the shareholder in question is a private equity firm is also significant given the negative press that has been focused on the buyout industry. Indeed, Gueguen argues that there is a further tendency in French courts to rule against buyout houses on the basis that the high levels of leverage used constitute an act of mismanagement. "Unions have developed the feeling that private equity funds imposed too much debt on companies and created situations that were unsustainable," she says.

Extending responsibility

So what is the net result of all this? For private equity firms looking to sell a French business, it is imperative there is evidence that the buyer has the capability to ensure continuity of the business. Says Gueguen: "The major focus is on the business plan. A good idea is to get a letter of comfort from banks, evidencing that they have viewed the business plan and feel sufficiently confident that they are prepared to provide working capital or credit facilities."

But this is only half of the story. It is equally critical that the buyer has proven resources and experience to deliver the business plan, which could mean that smaller turnaround buyout funds become a less attractive option. "It is important to sell to somebody that has a strong reputation in the sector and that is capable of showing it has sufficient resources. This inevitably means that large strategic buyers as well as solid private equity houses are well-positioned," Gueguen continues.

Based on these requirements it is hard to argue that the law is over-zealous, being as it merely emphasises to owners that their responsibility does not end when a company is sold. However, care does need to be taken in how the law is applied: making it overly difficult for a struggling fund to sell an ailing business is not the best way to ensure that the company in question has a future. For private equity funds, the focus when selling needs to be on the future of the business rather than the size of the bid, as what seems like a good deal could prove costly in the long term.

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• Topics
• Regulation
• France