GOVERNANCE A compromising position?

Evidence is emerging of senior lenders being prepared to question the independence of boards of directors at troubled private equity-backed companies. These lenders are skeptical of the boards' dedication to finding restructuring options beneficial to all creditors and not just the private equity owner.

According to Patrick Fodale, a managing director with investment bank Loughlin Meghji, this has already produced one unique situation he has never encountered in the past.

Fodale, who has worked with both lenders and private equity firms, is working on a restructuring of a private equity-backed company in which the senior lenders have requested the company's board of directors be made more independent as part of the restructuring. The plan has not yet been approved, but the private equity firm is not happy with the lenders' demand to restructure the board, Fodale says.

“The boards are supposed to be independent …the private equity board members are in essence trying to serve two masters – their own stakeholders in the private equity firm as well as serving the board in their fiduciary responsibility,” Fodale says. “The banks are claiming they're not independent.”

When a company goes into bankruptcy, the directors become responsible to all the companies' creditors and not just one stakeholder.

A recent case illustrates some of the roadblocks that can arise from boards stacked with employees of private equity owners.

JLL Partners and Warburg Pincus have proposed a $173 million recapitalisation plan for portfolio company Builders First- Source. The plan is opposed by a group of shareholders in the public company for various reasons, including that the company's board is overloaded with representatives of the private equity firms.

The group alleges that the company's board of directors is not acting in the best interest of the company, but only in the interest of the private equity firms. The two firms hold six out of 10 board seats between them.

Shareholders are suing the directors for breaching their fiduciary duty.

“Senior secured lenders are the fulcrum and they have to address the issue. They've allowed private equity firms, when the acquisition was made, to put their own people on the board,” says Adam Sell, a director with Loughlin Meghji.

“Now that times are tough, they say, “wow, I've got a board of directors that is nearly controlled by the private equity partners – how do I know when we're working on a consensual restructuring plan that they're really thinking of all the stakeholders versus how to salvage their investment?”” he says.