Overview and Background. Earlier this month, the European Commission penalized a group of high voltage power cable producers for operating as an illegal cartel and additionally penalized the Goldman Sachs Group, Inc. (Goldman) under a theory of derivative parental liability because one of Goldman’s private equity funds owned Prysmian, one of the cable producers. Prysmian, an Italian company, is the world’s top cable producer and was acquired by Goldman through one of its private equity funds in 2005. The fund reduced its ownership in Prysmian to a 43% minority share in 2007 and had completely divested its ownership by 2010.
The European Commission fined the infringing cable producers and also issued a €37.3 million (approximately $50 million) fine to Goldman, highlighting the European Commission’s position that private equity firms and funds may be exposed to liability for illegal activities by their portfolio companies, even when the funds are involved only in the high-level commercial policies of such companies.2
Parental Liability. The European Commission’s decision reflects a trend of expanding parental liability in the European Union (the EU), and it has become increasingly common for parent entities to be fined for violations of their subsidiaries. In the EU, a parent entity may be held liable for the illegal activity of a subsidiary or portfolio company if it exercises “decisive influence” over the infringing entity, which may be based on any economic, organizational or legal link. The European Commission considers a variety of factors that may show practical influence over another entity, including significant involvement at the board level, the right to appoint senior managers, veto rights over matters such as the annual budget or business plans and commonality of assets, systems and employees. Further, the European Commission does not require that the parent entity be involved in the illegal behavior of the infringing entity; it is sufficient if the parent entity exercises influence over the infringing entity’s commercial policies in general. Therefore, a parent entity may be held derivatively liable for the illegal activities of its subsidiaries or portfolio companies despite having only a minority ownership or no legal ownership interest at all and having no involvement in the purported illegal activity.
Consistent with this trend, the European Commission fined Goldman even though it has not suggested that Goldman or its employees had any knowledge or involvement in Prysmian’s collusive behavior. Instead, the European Commission found Goldman liable based only on its determination that Goldman, through the private equity fund that owned Prysmian, exercised “decisive influence” over Prysmian during the years of its ownership, including for the period in which it did not own a majority share. According to the European Commission’s public statements, Goldman had “direct involvement” in Prysmian’s management because (i) it appointed members of the Prysmian board who approved important strategic decisions and (ii) it was regularly updated about Prysmian’s business operations. The European Commission further emphasized that financial investment companies have a responsibility to look closely at whether their portfolio companies comply with EU laws and to take steps to ensure that a “compliance culture” exists within those companies.
Implications for Private Funds. The European Commission’s approach to parental liability is very different from the framework applied by courts in the United States. In the United States, if a parent entity is not directly involved in the illegal activity at issue, courts generally may pierce the corporate veil only if the infringing entity is exclusively and completely dominated by the parent. The EU’s “decisive influence” test allows for much broader liability. Thus, private funds holding EU-based portfolio companies may wish to consider taking certain additional steps to limit exposure for derivative parental liability, including (to the extent it is commercially feasible):
- Due Diligence. The due diligence stage prior to making an investment presents the best opportunity for funds to evaluate the risk that their portfolio companies may be engaging (or may in the future engage) in illegal activities, including infringement of European competition laws).
- Contractual Arrangements. Firms should consider including in their funds’ deal documents (a) indemnity provisions that specifically cover potential competition law violations by a portfolio company and (b) provisions that allocate liability to their portfolio companies in the event that penalties are levied for illegal activities.
- Independent Operations. Firms may want to limit their influence in the operations of their portfolio companies, specifically by (a) reducing their involvement at the board level, (b) giving up the right to appoint senior managers or veto certain matters such as the annual budget or business plans, and (c) reducing or eliminating any commonality of assets, systems and employees.
In light of the European Commission’s recent decision, private equity firms should examine their European portfolio companies more closely to ensure such companies have sufficient compliance policies and procedures in place to identify and correct inappropriate behavior and should determine whether any additional steps should be taken to minimize parental liability in Europe.