There is a saying that a man who serves as his own lawyer has a fool for a client. The same may be true for a fund that rushes to act as its own shareholder representative without thinking through the consequences.
Chances are you don’t cut your own hair, mow your own lawn or do your own taxes. So why, after selling your portfolio company, would you—a principal of a PE fund—agree to serve as a principal shareholder representative in post-closing litigation matters? The knee-jerk response is typically, “because I want to keep control.” But that control could come at a serious cost and there may be ways to maintain a reasonable level of control without exposing your fund to the unnecessary risks and expenses associated with being a named defendant in post-closing litigation.
A recent holding by the United States District Court for the District of Massachusetts in Mercury Systems v. Shareholder Representative Services LLC (D. Mass. February 14, 2014) is instructive. In that case, the plaintiff buyer attempted to include both the shareholder representative service company and the selling stockholders as defendants in a class action suit. And in support of its motion, the plaintiff pointed to documentary evidence arguably showing that certain shareholders and a “shareholders committee” were directly involved in the review of the plaintiff’s claims and dictated how the shareholder representative services company should respond to the plaintiff’s allegations. The court nevertheless denied the plaintiff’s motion for class certification and dismissed the individual shareholders from the case, holding that “all the certification of a class of defendant security holders will accomplish is an escalation of the procedural complexity of this litigation and its cost, while eviscerating the salutary purpose of having appointed a shareholder representative in the first place.” Id. at 1. (citing Ballenger v. Applied Digital Solutions, Inc. (Del. Ch. April 24, 2002) (noting common practice of appointing shareholder representative as helpful mechanism for resolving post-closing disputes efficiently)).
Clearly, you want a strong shareholder representative to represent your interests and those of the other selling stockholders. You want to keep your money and mount a strong defense. But does your PE shop really want key employees’ attention diverted by haggling over representations and warranties, perhaps only to be named in a lawsuit and possibly positioned against someone you might want to do business with again?
Before you agree to take on the role of a shareholder representative, be sure to think about the risks and the rewards and whether outsourcing is a better choice for your fund. Are you raising capital in the near future? Could being a named defendant adversely impact that fundraising? Will you possibly see this buyer again in another context? Do you have the right human resources? Ask your deal lawyer—and a litigator who has been through post-closing drama—to discuss your options with you. Is there a suitable professional service company that can represent the sellers’ interest while limiting your fund’s litigation exposure?
Make your decision thoughtfully. Being dragged into litigation is no joke.