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Volume XIII, Number 154


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Portfolio Companies in Distress: Navigating the Risks from SVB and Other Threats to Liquidity and Solvency

Everything, everywhere, all at once is our risk thesis for 2023, but one must not forget about concentration risk.  This issue has rocketed up diligence agendas for LPs and GPs alike as the collapse of Silicon Valley Bank proved it really was the bank for venture capital.The entry of SVB into receivership on March 10, 2023 highlighted just how central it had become to U.S. venture capital, providing deposit and credit facilities not just to asset managers, but also to many (and in some cases the vast majority) of their portfolio companies and investors.  While deposit accounts were protected in full, companies unable to access those accounts for several days faced significant disruption.  Further, while borrowers were still bound by terms of credit agreements, there was no immediate obligation on the Federal Deposit Insurance Corporation (FDIC) as receiver to honor drawdown requests (although the bridge bank did announce it would honor credit facilities). Net asset value (NAV) lines, subscription lines and investors’ own deposit and credit lines were also affected. The deposits and loans of SVB were acquired from FDIC by First Citizens Bank on March 27, 2023.

The parallel troubles of crypto specialist Signature Bank (the majority of whose deposits and branches were sold to New York Community Bancorp on March 19, 2023) and national Swiss institution Credit Suisse (acquired by UBS on the same date) emphasized that private capital remains instinctually linked to traditional banking, not just in terms of wider market trends but also in reliance on its fundamental services. The U.S., UK and Swiss governments quickly acted this month, together with the banking industry, to take decisive steps to reassure the public and the markets but this likely won’t be the last such shock.

Financial distress of investee companies, whether in the form of sudden lack of access to cash as with SVB or longer-term liquidity concerns, raises a myriad of issues for asset managers, especially where investor representatives sit on the boards of their portfolio companies.

First, and most immediately, cash flow issues can put companies at risk of default under their loan terms.  Sponsors that decide to provide rescue cash to their investee companies to prevent or cure such a default must look carefully at the terms of any emergency issues or creation of new shares to ensure they follow the process in the Articles or Shareholders’ Agreement and abide by any pre-emption rights. These areas are prime ground for minority shareholder petitions and challenges.  Sponsor-appointed board designees must also be alert to their personal conflicts and ensure these are declared and managed.

Second, several U.S. states impose civil or criminal liability on directors and officers where a company fails to pay wages. This was an acute concern for many companies banking with SVB.  Similar payroll delay or “wage theft” laws exist in other non-US jurisdictions, including Norway and certain Australian states.

Next, the duties of directors may change even before the moment of insolvency. Directors of companies in or approaching the “zone of insolvency” need to be aware that, in some jurisdictions including the UK, they may need to start to take interests of creditors into account even before the onset of (or inevitability of) a formal insolvency process, while maintaining their duties to shareholders.  Delaware law negates fiduciary duties to creditors, even in insolvency, to avoid putting directors and officers into analysis paralysis as to which constituents to serve. 

Where a portfolio company enters insolvency, insolvency practitioners, bankruptcy courts, and other parties in interest have wide powers to review transactions and payments, often looking back several years in the event of alleged undervalues, constructive or actual fraud on creditors, or impermissible transfers. Under the English scheme, liquidators in previous downturns looked closely at fees charged by asset managers for services to portfolio companies to ensure these were genuine repayments of intra-group debt, and recapitalizations to ascertain if there was any claim against a private equity shareholder or related individuals. They also investigated recent share repurchases as these may give rise to a separate power to require contributions from past directors and shareholders. 

The typical exculpation and indemnification provisions in fund documents, or D&O insurance, applying to directors often contain carve outs for fraud and intentional conduct (although see the SEC’s recent proposals discussed in our forthcoming post on the topic).  Typically, chapter 11 plans in the U.S. contain similar exculpation clauses intended to insulate directors and other stakeholders from liability in carrying out the bankruptcy cases. But there is a growing circuit split in the U.S. regarding whether such clauses are permissible because they are tied up in the dispute over the statutory and constitutional questions as to whether non-debtors can be released. Some actors, such as a trustee or statutory committee member, have quasi-immunity by virtue of their serving as officers of the court.

In short, March 2023 has been a salutary reminder of the need for two core fundamentals: cash and diversification (including in where you keep your bank account).  

Joshua M. NewvilleTodd J. OhlmsRobert PommerSeetha RamachandranRobert SuttonJohn VerweyJonathan M. WeissJulia AlonzoJulia M. AnsanelliCharles BishopMassimo B. CapizziWilliam D. DalsenAdam L. DemingReut N. SamuelsMichael Singh and Hena M. Vora also contributed to this article.

© 2023 Proskauer Rose LLP. National Law Review, Volume XIII, Number 89

About this Author

Margaret A Dale, Commercial Litigation, Proskauer Rose Law Firm

Margaret Dale is a Partner in the Litigation Department, resident in the New York office. Her practice focuses on commercial litigation, including class action defense, as well as intellectual property, privacy and data security, corporate governance litigation, securities litigation, and regulatory and internal investigations. She also represents and counsels clients in art law matters. 

Michael R. Hackett, Litigation Attorney, Proskauer Law Firm

Michael R. Hackett is an associate in the Litigation Department and a member of the Asset Management Litigation practice. His practice focuses on disputes and regulation involving private funds, including private equity, venture capital, hedge, real estate and private credit funds, as well as other limited partnerships, where he regularly advises funds, fund sponsors, investment advisers and institutional and individual investors.

Mike’s experience representing private fund clients runs the gamut, from control contests within advisers, to...

William Komaroff Litigation White Collar Attorney Proskauer Law Firm New York

Bill Komaroff is a partner in the Litigation Department and White Collar Practice Group. He has a nationwide federal practice focused on corporate defense and investigations, counseling and defending institutional and individual clients in connection with a broad array of complex government investigations, prosecutions and civil disputes.

Bill also has served as a member of the Criminal Justice Act Panel for the District Court for the Southern District of New York.

From 2003 to 2007, Bill served as an Assistant U.S....

Nathan R Lander, Insurance Attorney, Proskauer Rose Law Firm
Senior Counsel

Nathan Lander is a senior Associate in the Litigation Department and Insurance Recovery & Counseling Group, resident in the New York office. He has extensive experience representing policyholders in disputes with their insurance companies, and litigating insurance coverage issues in federal and state courts around the country.

Timothy W. Mungovan, Litigation Attorney, Proskauer Law Firm

Timothy Mungovan is a Partner in the Litigation Department, co-head of the Private Investment Funds Disputes practice and a member of the Private Investment Funds Group. Tim has an international practice in complex commercial litigation, advising public and private companies in a variety of areas, including securities, corporate governance, fiduciary obligations, investment management and financial services, fraud and trade secrets.

In addition to his regular commercial litigation practice, Tim focuses on disputes involving private investment...

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