The perils within companies

Question: What happens when a “stakeholder” — an interested board of directors, holding company, investor, private equity firm or hedge fund — oversteps its bounds and controls the day-to-day operation of a company? Answer: Legally speaking, nothing good.

“As a stakeholder, you have to think about how your actions appear to an outsider looking in,” says Jason S. Oletsky, member and co-chair of the litigation department at Kluger, Peretz, Kaplan & Berlin P.L. “Does it look like you’re acting properly through the company’s board of directors or like an investor trying to control the company’s day-to-day actions?”

Oletsky counsels stakeholders on how to balance their majority financial position and independence from the companies in which they serve on the boards of directors and own majority interests.

Smart Business talked to him about the legal ramifications of trying to exercise too much control.

Are there limits to how much control an investor can have over a company’s day-today activities?

Absolutely. Although there is no specific statutory framework involved, courts look for an investor’s exercise of excessive control that created — and breached — a fiduciary duty thereby creating a co-employer relationship, or alter ego liability.

Ideally, an investor should have no direct say over a company’s day-to-day operations. Today, however, where private equity and hedge funds are so heavily invested in companies, it is unrealistic to believe that investors won’t have their say in their companies’ operations. The key is to properly structure this control through corporate governance.

From the stakeholder’s perspective what is the issue?

It’s a balancing act. The stakeholder has a duty to return the greatest investment possible to its investors. If they are a board member, however, they owe a fiduciary duty to the shareholders of the company. If those distinctions become blurred and it is determined the stakeholder has exercised excessive control, it could become liable for company debts.

If proper controls and governance are in place, the investor can still exercise control and oversight, but without the threat of personal liability.

Can you cite an example?

The most common examples I’ve seen thus far usually arise either in bankruptcy or distressed company situations. For instance, if a financially struggling company is forced into a mass layoff, federal law requires that the affected employees receive 60 days’ advance notice. The chances of employees recovering against such a company are minimal, but, if they can show that an investor had too much of a say in the mass layoff and proper corporate formalities were not followed, the investor can be deemed a ‘co-employer’ and subsequently be responsible for the employees’ statutory right to pay.

Additionally, where a company is in the ‘zone of insolvency,’ the board’s fiduciary duty shifts from shareholders to creditors. If the board, influenced by the stakeholder, takes actions adverse to interests of the creditors, it can be held liable for company debts.

What are some indications of excessive control that you see and counsel against?

Generally, it’s a precarious position for the investor who attempts to control the daily financial affairs of the company. While it is permissible for a company’s board to have ultimate say over these types of decisions if handled properly, where direct dialogue from the investor to the company executives occurs, problems can arise.

Other mistakes, just to name a few:

• Direct e-mails telling a company president what to do concerning day-to-day operations.
•  Issuing press releases on behalf of the company creating the appearance of investor involvement.
• Intermingling bank accounts.

What steps do you recommend for avoiding excessive control allegations?

Insure that corporate formalities, such as board resolutions for important corporate decisions, are met.

• Limit the number of stakeholder personnel serving as officers and directors at the operating level.
• Include nonstakeholder personnel on the board.
• Limit investor in-house personnel at the operating level.
• Maintain separate books and records.
• Act through the board for company decisions, not through the investor.
• Don’t blur the distinction between investor and the operating company in corporate communications.
• Have sufficient operating capital at the operating company separate and apart from the stakeholder.

 The most important piece of advice, don’t get lazy. Think about what your actions are going to look like to the outside world before you act and go from there. To view the article, please click here.

JASON S. OLETSKY is a member and co-chair of the litigation department at Kluger, Peretz, Kaplan & Berlin P.L. Reach him at (305) 341-3014 or joletsky@kpkb.com. He has been nationally recognized by Best Lawyers in America in the area of private funds/private equity law.