New York’s High Court Allows “Alter Ego” Claims Directly against PE Firms for Portfolio Company Bond Debt

In an overlooked aspect of the recent New York Court of Appeals decision in Cortlandt St. Recovery Corp. v. Bonderman1, New York’s high court has allowed direct claims to move forward against two private equity firms for the debt of their portfolio company under a bond indenture. The decision found that the two required elements for the direct claims were asserted sufficiently in the complaint in order to avoid dismissal, namely (i) that the private equity firms controlled and “dominated” the affairs of the portfolio company and (ii) that the portfolio company’s redemption of their equity “perpetrat[ed] a wrong or injustice” or “otherwise resulted in wrongful or inequitable consequences.”2

Asserting “inequitable consequences” of equity redemption by “dominated” portfolio company found sufficient for bond trustee to proceed directly against PE firms

The decision has been widely discussed for its holding confirming an indenture trustee’s broad standing to pursue all available remedies against an issuer and its affiliates so long as it is doing so on behalf of all bondholders under the related indenture. Less discussed, however, has been its holding and rationale with respect to the standards for potential liability of private equity sponsors for the debt of their portfolio companies. A private equity firm typically will control the affairs of its portfolio company through the latter’s board or other governing body, and will cause, indirectly through its director designees, actions to be taken at the portfolio company that benefit it, the private equity firm, as its owner. Will certain actions later be challengeable, when viewed in hindsight, as unfair to other stakeholders? And, if so, will a private equity firm potentially be liable for the debt of its portfolio company on an “alter ego” or “veil-piercing” theory? This decision, from New York’s highest court, will be looked to by courts in any jurisdiction interpreting claims under debt instruments governed by New York law, an extremely common governing law for debt instruments.3


In 2005, two private equity firms (Sponsors) acquired TIM Hellas Communications and its subsidiaries (collectively, Company), Greece’s third-largest cellular telephone provider, which prior to the acquisition had about a 20% market share in Greece’s mobile phone market, over €110 million in annual profits and a modest €187 million of debt. The acquisition transactions resulted in the Company’s incurring long-term debt of about €1.6 billion, as compared with shareholder equity of only about €38 million and, by mid-2006, its long-term debt increased to €1.94 billion, with shareholders equity dropping to just €11.4 million. In late 2006, the Company issued €200 million in PIK notes to bondholders under a New York law-governed indenture (PIK Notes). Proceeds of the PIK Notes issuance were combined with other cash on hand at the Company to redeem for cash certain preferred equity instruments held by the Sponsors, with the redemptions totaling about €973 million in cash. In 2007, the Sponsors sold the Company to another investment firm at a price of €3.4 billion, consisting of €500 million cash and the buyer’s assumption of the Company’s €2.9 billion in debt then outstanding. With the onset of the global financial crisis, the Company struggled and ultimately defaulted on the PIK Notes and went into insolvency administration in the United Kingdom in 2009.

The indenture trustee under the indenture governing the PIK Notes brought an action in New York state court against the Company and the Sponsors. The complaint alleged that the Company’s transactions were simply a scheme intended to “bleed-out” money from the Company and into the Sponsors by “paying out unlawful dividends – even though the Hellas Group was in considerable debt”.4 The complaint asserted causes of action for breach of contract and fraudulent conveyance, among others, and included claims directly against the Sponsors on an “alter ego” theory, asserting that “piercing the corporate veil” was appropriate under the circumstances alleged in the complaint. The complaint thus sought payment from the Sponsors of the €268 million claimed to be owing on the PIK Notes together with related interest, fees and enforcement expenses.5 The trial court dismissed the complaint, but on appeal, the intermediate New York appellate court reversed, and certified the following question to the state’s highest court, the New York Court of Appeals: “[W]hether an indenture trustee may seek recovery on behalf of noteholders for defendants’ alleged fraudulent redemptions intended to siphon off assets, leaving corporate obligors unable to pay the noteholders”.6