Section 101 under the microscope: the liability ‘poison pill’

We asked three chief financial officers to take a look at sections 101 and 102 of the Stop Wall Street Looting Act of 2019, co-written by Senator for Massachusetts Elizabeth Warren. The section on corporate responsibility, if ever approved, could have a significant impact on the private equity industry:

Section 101: Joint and Several Liability for Controlling Private Funds
Holds private funds that are control persons jointly and severally liable for all debt incurred by a target firm, including for legal judgments, liabilities in connection with violations of the Worker Adjustment and Retraining Notification (WARN) Act, and pension-related obligations.

Section 102: Joint and Several Liability for Holders of Economic Interests in Controlling Private Funds
Holds private funds that are control persons jointly and severally liable for all debt incurred by a target firm, including for legal judgments, liabilities in connection with violations of the WARN Act, and pension-related obligations.

“It’s definitely a short-term deal killer because there’s no way that GPs can handle the liability that this would imply,” one CFO tells us. “Because the GP is usually 1 percent to 5 percent of the equity and they are not large institutions. If it’s only liable to the GP, it is basically an industry poison pill.”

GPs would likely have to evaluate their insurance coverage for the theoretical risk of these liabilities. Dimitri Korvyakov, the CFO of Sandton Capital Partners, says this change will not only curtail leveraged buyouts, but all private equity investments.

“Portfolio companies generate all sorts of liabilities in the ordinary course of business,” he says. “The goal of the proposal is to limit aggressive overleveraging of portfolio companies, but as drafted, it will limit all private equity investing. To make private equity funds – i.e. shareholders – liable for all liabilities of portfolio companies is a drastic move away from the shareholders’ limited liability concept. It will hurt the investment landscape by increasing the cost of doing business; thus, equity risk premium.”

A third CFO believes that the bill, if passed, could have consequences outside of private equity. “It’ll certainly slow down the financial sector, including banks who’ll lose out on business,” he said. “This change would cause a huge economic and regulatory ripple effect that may not be intended.”

The bill is as yet a long way from becoming law. Says the first CFO: “I have a feeling there will be some guard rails, there’ll be something put into there that doesn’t make this such a  universal poison pill.”