How Sponsors Can Avoid Liability with Mark Freedlander

In this episode of The Professor’s Corner, Mark Freedlander is back to continue the discussion on the ways a sponsor company can find themselves liable if their portfolio companies enter financial distress. 

Having debt recharacterized as equity is the next level of exposure that sponsors need to understand. 

Simply calling something debt doesn’t cut it. Being unclear in the management of debt versus equity can open sponsors up to companion fraudulent conveyance claims if the courts recharacterize a company’s debt. 

The last piece of the liability puzzle focuses on breach of duty claims. If a sponsor is sitting on the board of one of their portfolio companies, they need to stay informed of the company, its financials, and potential liquidity issues. This awareness can be the difference between creating or avoiding liability issues. 

“When a portfolio company runs into trouble [...] it may very well make sense for an independent director to be brought into a company,” explains Mark. “Having an independent director that is truly independent can provide a significant level of protection to the financial sponsor or the equity sponsor.” 

For sponsors concerned about potential liability exposures, Mark offers insight into different situations that a sponsor may encounter, discussing the protection that is available to a sponsor who recognizes problems early and takes a cautious approach. 

This is the second episode in a two-part series. If you haven’t listened to the first half yet, check out the previous episode for an overview of statutes and claims that sponsors need to keep on their radar.  

 

Featured Guest

Name: Mark E. Freedlander

What he does: As a Partner at McGuireWoods, Mark has been advising clients about creative, business-oriented solutions to matters involving financial distress for the past 25 years. Mark is a goal-driven problem solver whose clients benefit from the creative, pragmatic, and strategic perspective he brings to each engagement.

Organization: McGuireWoods

Words of wisdom: “The more attention to detail you do pay, the better that your records are, the greater the level of deliberation about things that are close calls — the better off a sponsor will be.” 

Connect: LinkedIn

 

Notes From the Professor’s Corner

Top takeaways from this episode

• Calling something debt doesn’t mean it’s debt in the eyes of the law. According to Mark, recharacterization of debt will occur under common law, and the courts may consider debt instruments to be equity, which can add additional exposure to the sponsor. 
• Sponsors can be liable when you can’t differentiate the sponsor and the portfolio company. Liability is often created when the sponsor has significant control over its troubled portfolio company. The most common instances arise under ERISA for anything from COBRA claims, warrant claims, or pension plans. 
• Sponsors who sit on the board of portfolio companies need to be informed. Board members have a duty of care and a duty of liability that needs to be fulfilled. Awareness of what’s happening with the company, its financials, and any potential liquidity issues can be the difference between creating or avoiding a liability situation.

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