Impact of COVID-19 on private equity portfolio companies: Guidelines for dealing with distress

It is simply too soon to tell whether the COVID-19 (or coronavirus) pandemic will lead to an economic crisis, but it is a fact that the consequences are already clearly felt in many branches, such as the supply chain industry, leisure industry and aviation industry. It becomes more likely that investors will face a financially distressed company among their portfolio companies. Especially in these turbulent times, proper management is crucial in view of the preservation of the business, control over insolvency risks and – also important – to avoid directors’ liability.

Below are some guidelines that investors and the managers of their Dutch portfolio companies could bear in mind when performing their duties as directors. If the portfolio company concerned has a one-tier-board the following guidelines apply to the entire board, also the non-executives. If the portfolio company has a two-tier board (the majority), then the below guidelines apply to the management board (bestuur). This also applies to de facto managers (feitelijk leidinggevenden).

We emphasise that these guidelines are not limitative nor do they comprehend all possible directors’ liability varieties. They do, however, provide you with a quick and useful overview of attention points.

Guidelines to be kept in mind by the management board (in a two-tier  board) and the entire board (also non-executives, in case of a one-tier board) and de facto managers (in general). Members of the management board (in a two-tier board) and the entire board (including non-executives) and also de facto managers (in general) should:

• Properly perform their duty in the context of the director’s responsibilities. This means that the management board considers the best interests of the company and all its stakeholders.
• Act in the best interest of all creditors – and not favouring one creditor over the other.
• Carefully consider the transactions that the company is entering into. This is especially the case where it concerns intragroup transactions, transactions with affiliated parties and those transactions where the terms are not market standard and/or at arm’s length. Special attention is also required for transactions which involve setting off claims ‘in the twilight zone before bankruptcy’. These transactions can under certain circumstances be annulled by the future insolvency practitioner. This is especially the case in transactions with affiliated parties or family members of the directors.

This also goes for cases where parties manoeuvre themselves in a setting-off position:

• Fully and carefully document and record all decisions and considerations that are being made supporting the policy being conducted by the management board and the underlying grounds thereof in a way that proves that the policy pursued by the company has been carefully considered. Any expert recommendations obtained supporting the decisions made and policy pursued should also be included. These documents and records will be helpful should the company be placed into a formal insolvency process and the decisions and management of the management board are under investigation.
• Find a fair balance between the best interests of the company and the interests of other parties involved. Once the crucial moment has passed or is near when a management board member knows (or ought to know) that the company will become insolvent in the near future the acts of the management board will be key when it comes to minimising losses of (future) creditors. Guidelines to be kept in mind by the supervisory board (in case of a two-tier board).

The members of the supervisory board should also bear in mind that a proper performance of their duties in a two-tier board company is crucial. Also, and especially when it comes to a company in distress, the supervisory board members should be:

• Aware that where they perform “acts of management”, the same standards as indicated above apply. For instance, this is the case when the supervisory board is entitled and obliged (in absence of a conflict of interest of the supervisory board) to resolve on certain items due to a conflict of interest of all the members of the management board, pursuant to which the management board is not able to resolve on certain topics. This may also be case when the articles of association of the company provide for such entitlements for the supervisory board.
• In compliance with their duty to decent task performance. The task of the supervisory board is to supervise the policy of the management board, the general course of affairs in the company and its affiliated companies, and to assist the management board with advice. In the performance of their duties, supervisory directors must put the interests of the company first. Each supervisory director is obliged vis-à-vis the company to properly perform the task assigned to it. Supervisory board members must ensure that they properly perform the tasks assigned to them, such as supervision of the board of management and be well aware that they take the powers granted to them very serious, such as suspension of board members. These powers must not be used to easily.

Keeping control over insolvency risks

In these turbulent times, you may want to be more cautious when it comes to keeping control over insolvency risks. The following principles and considerations may be helpful when it comes to keeping control over the aforementioned risks and mitigating the risks of liability:

• decisions with far-reaching financial consequences require proper preparation
• credit control is of the utmost importance
• at all times comply with the obligation to keep the supervisory board well informed when it comes to the decision making process
• proactive approach when it comes to the covering of clearly foreseeable risks
• comply with the duties towards and the policy as regards the employees of the company
• if need be, attain the assistance of experts when it comes to entering into important transactions
• at all times, serving the interests of the company is the first priority.

Taking timely measures to control insolvency In order to control the insolvency risks of the portfolio company you might consider the following measures:

• being alert to any signs of financial distress or weakness of the business model
• explore the financial position of the company and learn whether the solvency and liquidity position of the company requires for any expert assistance
• exploring the opportunities to seek for governmental financial support
• exploring the opportunities to deal with inevitable and significant business disruption, for instance by applying for a reduction in working hours and part-time unemployment benefits of the employees; if the work reduction is more structural, then a (collective) dismissal procedure can be considered for economic reasons
• seeking further investment while dealing with the inevitable and significant business disruption that will result from COVID-19
• identify the financial position of your business partners, to investigate whether they will be able to comply with their payment or delivery obligations; you might want to consider to increase your position by asking for additional security for proper fulfilment of the obligations by your business partners
• intelligent communication with the business partners (suppliers, customers, finance parties and the like) when you face inability to comply with your contractual obligations
• making the best of the solutions offered by the tax authorities when it comes to deferment of corporate income taxes, VAT, and other taxes
• timely communication with the tax authorities in case of expected inability to pay.

Conclusion

We are all facing a changing environment at the moment, which brings with it a lot of uncertainty. Where portfolio companies are concerned, it is certain that an appropriate strategy is of key importance. In a distressed situation, acting in an adequate and timely manner is crucial, and the investors and management of portfolio companies should be cautious when it comes to directors liability.