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.