Corporate / M&A

Poland: Divided Loyalty? How to Rule Out a Conflict of Interest in Management Buy-Outs

A management buy-out (MBO) is a tempting possibility for many managers. The question is how to avoid a conflict of interest and liability toward the company and its shareholders.

Risk of conflict of interest

MBOs are more and more popular among management staff as they give a chance of becoming co-owners of the managed company. However, MBOs create a risk of a conflict of interest. From the perspective of a separation of management and ownership spheres in capital companies, the interests of shareholders usually differ from those of management board members. An MBO, as a transaction leading to a meeting of those two spheres, must thus address.

A basic source of conflict of interest in an MBO is the fact that the same entities appear on both sides of the deal. On the one side, managers are insiders, with profound knowledge of the company’s current business and its prospects. On the other side, they are leading the team attempting an acquisition at the best price.

The basic source of risk is the wide access of management board members to internal and confidential data of the company, including that regarding its financial condition and development potential.

Conflict of interest regulations

A basic obligation of management board members is loyalty towards the company. This is reflected in several provisions of the Polish Commercial Companies Code, aimed at reducing the risk of conflict of interest. If a company’s interest clashes with that of a management board member or his relatives, the member should refrain from deciding on such issues, and may wish to indicate this fact in the minutes of the board meeting.

Further, transferring, disclosing or using company’s information that is a trade secret can constitute an act of unfair competition if it threatens or infringes an interest of a company.

A basic rule resulting from the above regulations is an obligation of management board members to act in the interest of the company. If management board members breach this, they may be civilly or criminally liable. A special case of liability is when a management board member is a company employee at the same time. The Supreme Court has held that, in such cases, corporate and employment liability are independent of each other, and liability for a given act or omission is determined case by case.

How to mitigate the risk

The main source of conflict of interest is the fact that managers have a double role: members of the management board of the company to be purchased, and purchasers. One way to avoid a conflict is to plan an MBO transaction to delay as long as possible the time when management board members have a double role.

Various strategies may be used to move management board members away from participating in the deal on both sides. The most frequent is to form a special purpose vehicle (SPV) for an MBO. Management board members contribute funds to the SPV provided for a purchase of shares in the company they manage. The remaining funds come from other institutions financing the MBO (mainly banks and private equity funds). In negotiations with the target company, representatives of such institutions often act on behalf of the SPV instead of as managers.

Having many participants in the deal reduces the risk that management board members will act under a conflict of interest, facilitate getting more funds to finance the undertaking, and increase the chance of success.

Special attention should be devoted (i) to disclosure of sensitive information to other parties in the buyout, including the sponsors (typically private equity funds) and (ii) to avoiding exclusivity provisions that would bind the company. It is acceptable for the managers to undertake towards the sponsors that they will not engage in other buyout offers. But any undertaking limiting the company and the other shareholders from pursuing other financing or sale options is possible grounds for a dispute.

Also, to ensure that the offer made to the current shareholders is justified from the viewpoint of the company and current shareholders, an analysis of the alternative options (including the value available to the shareholder under such options) should be prepared.

In case of an MBO in a joint-stock company, rules for financial assistance given by that company to third parties, including management board members, should also be considered. Under current provisions, financial assistance is permitted if certain conditions are met, one of them being to conduct a transaction under market rules.

Having many participants in the deal reduces the risk that management board members will act under a conflict of interest, facilitate getting more funds to finance the undertaking, and increase the chance of success.