US private equity firms operating in Europe are constantly reminded of the need to take account of the region's challenging cultural and legal environment. But perhaps nothing could have prepared Washington-DC based private equity firm The Carlyle Group for the threats, recriminations and court battles that plagued its investment in French portfolio company Otor once its relationship with management had soured (see boxed item next page).
For Carlyle ? after several years of strife – there appears finally to be a happy ending in sight in its efforts to wrest majority control of the paper products business from its founders. But the message of the sorry tale resounds loud and clear: if you want to remove management teams in Europe, it's wise to be prepared for a long, hard and possibly dirty fight.
It won't stop private equity firms from trying, though. There are two main reasons for wanting to dispose of management. The first is related to unexpectedly poor performance. The second is when a GP is attempting to buy a company and, for whatever reason, the incumbent team simply doesn't form part of its plans. This is problematic since the existing managementmay have done nothing wrong aside from not fitting well with a strategic plan ? and this could lead to claims of unfair dismissal.
In practice, a pragmatic solution will be sought ? which normally means a pay-off in exchange for waiving employment law rights. Whether the size of the pay-off has a meaningful impact on the buyer's intentions will depend on the size of the deal. According to one source at an executive search firm, a UK CEO earning £250,000 a year could reasonably expect a pay-off of between 12 to 18 months' salary (i.e., up to £375,000): perhaps not a major consideration if the deal size is £500 million, but almost certainly a factor to take into account if it's just a few million.
If management refuse to accept the offer, the chances are that in most cases the would-be acquirer will simply walk away from the deal. ?At the end of the day we're trying to back management teams,? says James Barbour-Smith, a director at London-based mid-market buyout firm Gresham.?If it's a good asset but the wrong management ? as a result of which you just can't get comfortable ? then you won't do the deal.?
HIT THE TARGET
But what happens when problems with management only surface some time after the investment has been made? On the one hand, the GP will have recourse to a contractual agreement drawn up with management at the time of the deal. This will normally contain stated performance targets for management to hit. ?If you're trying to replace a manager two to three years postinvestment it can be difficult because you have to demonstrate that their performance has not been up to scratch. But if you've set out clear EBITDA targets, for example, that makes it slightly easier,?says Barbara Moors, an assignment manager in the Paris office of executive search firm Heidrick & Struggles.
It is almost certainly true that if you objectify performance in this way, rather than it being your own personal view that management has underperformed, you can bring more pressure to bear. The problem is that contractual agreements drawn up between a private equity firm and management will normally sit alongside employment contracts based on the statutory law of the country in question ? and the former does not replace the latter. Therefore, performance targets are normally linked to the payment or otherwise of bonuses ? not directly to dismissal.
?A failure to meet performance targets does not normally provide an automatic contractual right to terminate a contract,? says Blair Adams, an employment lawyer at the London office of US-based law firm O'Melveny & Myers (though it should be noted that, in the case of Otor, failure by management to meet profitability targets was viewed as sufficient reason for Carlyle to be granted majority control of the firm by an arbitration court).
How can you remove management if not because of an inability to hit stated targets? The answer, on the face of it, is ?not easily?. Consider this extract from a note sent to clients by a leading law firm regarding employment law in France:?A dismissal can be based on reasons linked to the employee, that is, their fault(s), incompetence or the incompatibility of their skills with their role. The reason will only be a valid ground for termination if the employer can provide objective evidence of the employee's fault(s), incompetence or incompatibility which is serious enough to render the continuation of the employment relationship impossible.?
Such words probably sound like a threat to the ears of most employers, though how they will be interpreted in individual cases is, of course, a matter of conjecture. Interestingly, though, professionals on the ground in France freely admit that there is a culture of both private equity funds and management taking aggressive stances. ?I have always found it easier dealing with US funds than French funds because they have more of a culture of agreement and normally manage to resolve matters without a fight,? says Ann-Elisabeth Combes, a partner at Paris law firm Jeantet Associes. ?In France it can be more difficult to reach agreement.?
Unwillingness to reach an agreement could mean a world of pain for an employer in a country like France. Domestic employment law dictates that any termination judged ?unfair or abusive?means the employer is held liable to compensation for the ?prejudice suffered? on top of the basic termination costs. In such circumstances, employees can at least expect six months salary and in practice frequently up to two years' worth. In addition, the employer might be forced to reimburse the state for any unemploymentbenefits paid out for the duration of any legal action.
An even bigger prize for the employee could be up for grabs if he or she is able to demonstrate that the statutory termination procedure was not correctly adhered to. Information website Frenchlaw.com notes:?Failure to follow the procedural steps, even where the dismissal is manifestly justified on the merits, may result in the courts overturning the dismissal and ordering the reinstatement of the employee.? Given that the procedure normally involves, firstly, written notice (to the employees' home address);secondly, a formal meeting between employer and employee; and, thirdly, consultation with the Works Council ? if one exists ? the procedure is neither swift nor straightforward.
In Germany, protection for employees is also strong ? particularly since the introduction of new rules implemented since January 1,2004. The rules place a strong emphasis on correct procedure for notifying employees of dismissals; the need to establish a ?good cause?; special protection against dismissal for certain groups of employees such as the disabled or pregnant women; and the need to consult Works Councils where they exist.
BerntWeller, an employment law specialist at Lovells in Frankfurt, says the need to observe highly demanding stipulations on correct procedure is ?a pitfall for foreign investors?in the country.?When we ask clients to serve several notices to an employee, they sometimes think that's bad advice because they see it an unnecessary. But non-observance [of the correct procedure] can result in the invalidity of the dismissal,? he adds. ?In Germany, you can challenge dismissals in court and the result can be re-employment.?
In the same client note referred to earlier, employment law in Germany is summarised in the following way:?Disputes over dismissals constitute a large proportion of labour disputes. Legislation and court rulings have, to a significant degree, restricted the employer's right to terminate employment. There are a number of requirements as to form and substance. If these requirements are disregarded, a dismissal will be invalid.?
Conversations with employment law specialists in France and Germany leave the impression of a system weighted in favor of the employee and against the employer. One caveat should be noted, however. In both countries, there is ? prima facie ? a difference in status between senior employees (in France, they are defined as ?legal representatives?) of a business and ?ordinary? employees, with the law designed to grant greater protection to the latter.
REMOVING RAYMONDA hypothetical sampling of dismissal dynamics across three countries. Assume a 45-year-old finance director, Raymond, with five years' employment, two of which are post buyout. He has a six months' contractual notice period. His salary package is €250,000 (inclusive of all benefits).
|Can the private|
|SCENARIO:||equity firm remove||France||Yes, but likely to lead to unfair dismissal claim|
|The private equity sponsor wants to||Raymond?||Germany||Yes, but likely to lead to claim|
|remove Raymond||Can Raymond be put||UK||Yes, but may lead to higher claim|
|because he is||on gardening leave||France||Has to receive dismissal letter, then yes|
|failing to meet||and taken out of the||Germany||Yes, but legitimacy of gardening leave is disputed, so may lead to higher claim|
|UK||Around €225,000 ? full six months' notice, plus estimated damages for wrongful/unfair|
|How much will||dismissal claims. Note that a successful discrimination claim on the grounds of sex or|
|removing||race could significantly increase this sum|
|Raymond cost?*||France||€250,000 to €312,500 ? full six months' notice plus 6-9 months' salary as damages|
|Germany||€275,000 to €325,000 ? full six months' notice period plus €150,000 to €200,000|
|damages, depending on his employment status|
|SCENARIO:||UK||Must inform him of allegations, give him time to prepare response, then hold meeting|
|Raymond is||How long will||to hear response, following which he can be dismissed. Allow several days, at least|
|suspected of||removing||three or more depending on the severity of the allegations|
|dishonesty and||France||Termination process takes a minimum of 10 days|
|the private equity||Germany||He must be given a hearing, and the Works' Council must be consulted at|
|sponsor wants||least one week in advance.|
|to remove him|
|immediately (the||Can Raymond be||UK||Yes|
|allegations are later|
|proved accurate)||during this process?||Germany||Yes|
THE BATTLE OF OTOR
When the Carlyle Group invested in Otor of France in 2000, it could not have imagined in its worst nightmares that five years on it would be emerging from a bitter legal dispute with the company's management team:
February 2000: The Carlyle Group announces investment of €45 million for a 20 percent stake in French paper products manufacturer Otor with the target company on the verge of bankruptcy.
March 2002: Otormanagement fails to meet profitability targets as set out in the shareholders' agreement. Carlyle says this allows it to take majority control of the company. Carlyle attempts to initiate an arbitration procedure, which Otor founders Jean-Yves Bacques (CEO) and Michele Bouvier (managing director) refuse to take part in, claiming the shareholders' agreement is invalid. Bacques and Bouvier take their case to the Paris county court. The court rules in Carlyle's favor, ordering Otor's founders to take part in the arbitration procedure and instructing them to pay costs.
February 2004: A judicial inquiry is commenced into suspected misuse of company property and false accounting at Otor, following disclosures made to the Paris public prosecutor by its auditor, Durand & Associes.
April 2004: Bacques says he wishes to remove Carlyle's representatives ? Jean?Pierre Millet, Franck Falezan and Jonathan Zafrani ? from Otor's board of directors at the firm's next general meeting in June. Carlyle says this would be a breach of the shareholder agreement.
June 2004: Millet, Falezan and Zafrani are evicted from Otor's board following a vote at the group's annual meeting not to renew their appointments. The meeting also votes to replace company auditor Durand & Associes ? which alerted the Paris public prosecutor to the firm ? with Bellot Mullenbach & Associes.
September 2004: Bacques takes Carlyle and French bank Credit Lyonnais to court in New York, seeking $200 million in damages and interest. Bacques claims there has been a conflict of interest ever since Carlyle invested in Otor in 2000, arising from Credit Lyonnais being an investor in one of Carlyle's funds at the same time as being a major creditor to Otor.
December 2004: Bacques and Bouvier are taken into custody as part of the legal investigation prompted by the findings of former auditor Durand & Associes.
March 2005: Bacques and Bouvier announce they are resigning from their posts until their dispute with Carlyle is resolved. The two men are replaced on an interim basis by Jean-Marie Paulte, chief operating officer, and Fabien Chalandon, a banking consultant to Otor.
April 2005: The French arbitration court rules in favour of Carlyle. The court instructs Bacques and Bouvier to convert the bonds held by Carlyle into shares, giving Carlyle control of Otor Finance, the holding company of Otor. The court agreed with Carlyle's claim that Otor has failed to meet profitability targets agreed as part of the deal signed in 2000. Bacques and Bouvier launch an appeal, which goes to the Paris appeals court.
June 2005: The Paris appeals court orders the immediate implementation of the original decision in favor of Carlyle. Carlyle says it will write to the chairman of Otor Finance immediately requesting the conversion of its bonds into shares, giving it control of the company. French small shareholders lobby group Appac says it has demanded the resignations of the Otor management team.
A Carlyle spokesperson told Private Equity Manager that change of control is expected imminently, while the US court case begun in September is ?not yet resolved, but is expected to be soon?according to the same spokesperson. Carlyle declined to comment on the details of the case.
EUROPE'S EMPLOYMENT SMORGASBORD
Step outside Europe's three largest buyout markets and the employment laws do not become any less complex. Each and every European country operates a distinct system of labor legislation and judicial enforcement:
AUSTRIA: Employment law based on a clear distinction between blue?and white?collar workers. Has a comprehensive system of collective agreements in place. Workers must belong to their local chamber of employees, which provides them with free legal advice. Special courts exist to handle labor disputes and there is a ban on dispute resolution through arbitration.
BELGIUM: Divided into three semi-autonomous regions: Flanders (Flemish speaking), Wallonia (French and German speaking) and Brussels (multi lingual). Making employment laws rests with the federal parliament, but enforcement of these laws is through locally administered labor courts. Labor standards are established and maintained through collective bargaining, with a plethora of industry agreements binding employers in particular sectors and geographical areas.
DENMARK: Strong emphasis on collective agreements. Employment law provides a framework for collective bargaining and then enforces the application of the resulting agreements. But there has been some movement in recent years away from dependence on social partner arrangements (between employer organisations and trade unions) and towards the direct application of statutory requirements.
FINLAND: Highly unionised. Terms and conditions of employment laid down within a framework of progressive employment laws and a two-yearly incomes policy agreement. New laws subject to extensive consultation with social partners and collective agreements become generally effective in a given sector if deemed appropriate by a tripartite committee.
IRELAND: Much of legal system similar to the UK. Generally adheres to EU social directives and was one of the first countries to introduce an integrated non-discrimination law giving protection to a wide range of social groups. The National Labour Court may issue binding recommendations on pay and conditions where trade union recognition does not exist.
ITALY:A strong legal framework exists for working conditions, the right of association and equality of opportunity. Many different parliamentary instruments used to introduce legal requirements ? from the Decreto Legge that lasts just three months, to the Delega Legislativo, which are frequently mistaken for full legal statutes but are actually just blueprints for potential law.
NETHERLANDS: Dutch employers must operate within a rigid system of statutory rights and obligations. The primary source of legal rights is book seven of the Dutch Civil Code (Burgerlijk Wetboek), which lays down the rules of employment contracts. Some variation in employment terms exists through the so-called ?three-quarter coercive? statutory provisions, which permit derogation through collective labor agreements.
SPAIN: A highly regulated labour market. The principal basis for all employment relationships is the Statute of Workers. At the age of 18, a Spanish worker may enter a binding contract that gives them a wide range of protection including generous compensation for objective dismissals (dismissal for economic, technical, production or organizational reasons).
SWEDEN: In spite of a high level of unionization, Sweden's principal mechanism for establishing employment standards is the law rather than collective bargaining. Unlike many of its neighbours, Sweden does not operate a system that permits collective agreements to have general effect within their sector.
SWITZERLAND:Employment contracts are subject to the Swiss law of obligation, and about half the working population are subject to standard contracts drawn up either by the country's 23 canton (regional) governments or a professional body. Dismissal is normally only lawful for either gross misconduct or