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Advising a Private Equity Fund
As anyone who has advised a private equity fund in connection with the potential insolvency of one of its portfolio companies knows, reconciling the duty of the fund's designated directors sitting on the portfolio company's board with the fund's duties to its investors can feel like a high wire act at times. As fiduciaries for its investors, the fund's managers must act in a manner consistent with maximizing the return on invested funds. Yet, these same managers are often directors of the fund's portfolio companies. While a portfolio company is thriving, the duties to the fund's investors and the fund manager's duties as a director of the portfolio company are typically in harmony. However, when the portfolio company's business turns sour, and it approaches insolvency or is insolvent, the shifting of the directors' fiduciary duties to the company's creditors can cause irreconcilable conflicts of interest along with consternation on how to fund ongoing operations.
This article discusses possible structural mechanisms to address and potentially avoid these irreconcilable conflicts while still maintaining the ability to manage the fund's investment and fund the portfolio company's ongoing business. However, at the outset, it is necessary to address three important caveats: 1) the overwhelming majority of portfolio companies do not end up with their directors facing claims from the company's creditors and private equity funds should not base their structural decisions solely on this concern; 2) the law of fiduciary duties in connection with insolvent and near insolvent entities is continuing to evolve, is intensely fact-oriented and varies from jurisdiction to jurisdiction; and 3) the protections discussed in this article will be analyzed by courts in highly fact-sensitive and retrospective review and may not withstand scrutiny in each circumstance.
Fund Formation
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