On 2 April 2014, the European Commission imposed fines totalling EUR 301.6 million on eleven producers of underground and submarine high voltage power cables for their participation in an alleged bid-rigging scheme. (Please click here for the Commission's press release). The decision is striking in that the Commission has significantly expanded its “parental liability” doctrine by applying it to a private equity management company in respect of an infringement committed by a portfolio company: it held fund manager Goldman Sachs Capital Partners jointly and severally liable for part of the EUR 104.6 million fine it imposed on Prysmian, an Italian cable maker that was acquired, for part of the alleged infringement period, by GS Capital Partners V, a fund managed by Goldman Sachs Capital Partners. This note sets out the background of this decision and suggests various ways to mitigate this new antitrust risk.
The Commission's Parental Liability Doctrine
In the EU, competition rules are addressed at "undertakings", that concept being defined as entities or groups of entities (companies or otherwise) that operate as a single economic unit. (This holds true both at central EU level and under the national competition rules of the 28 EU member states.)
Where an infringement of the competition rules is committed by a company that is part of a group, the Commission and EU national competition authorities have drawn on this technical definition to impose fines not only on that company, but also, under joint and several liability, on its ultimate parent company. This approach, which is referred to as the “Parental Liability Doctrine”, aims at enhancing the deterrent effect of fines and at preventing the parent company from allowing the subsidiary to go bankrupt in order to escape the fine.
Although this approach results in a situation where the corporate veil between the subsidiary concerned and its parent companies is pierced, the latter are not fined because of any independent, direct or indirect, involvement in or awareness or encouragement of the infringement, but merely because the parent companies are part of the same "undertaking" as the subsidiary that directly committed the infringement. This approach has been validated from the outset by the EU Courts (see, e.g., Case 107/82, AEG v. Commission [1983] ECR 3151, para. 50) and is automatically applied, in antitrust cases involving subsidiaries, by all EU competition authorities, i.e. both by the Commission and by the EU's 28 national competition authorities.
Expanding the Parental Liability Doctrine
A parent company and its subsidiaries will constitute a single economic unit when the parent can exercise "decisive influence" over the subsidiary, the standard of proof being that the subsidiary carries out, in all material respects, the instructions of the parent company.
In principle, it is not sufficient for an EU competition authority to merely find that the parent company is in a position to exercise decisive influence over the conduct of its subsidiary: it must demonstrate that influence was actually exercised. In practice, however, this test is relatively easy to satisfy: liability may be imposed on the parent even if its influence only relates to high level strategy or commercial policy and does not entail day to day instructions on how to run the business.
This doctrine has already been expanded in various ways.
First, under a rebuttable presumption rule recognized by the EU Courts, a 100% or near-100% shareholding gives rise to the rebuttable presumption that the parent has indeed exercised decisive influence over its subsidiary (Case C-97/08 P, Akzo Nobel and Others v. Commission [2009] ECR I-8237, para. 60). As a result, it is sufficient for the competition authority to prove that (almost) all of the capital in the subsidiary is held by the parent to attribute parental liability. (In the absence of a near 100% stake, the competition authority must prove the actual exercise of decisive influence). That presumption can in principle be rebutted by showing that the subsidiary has actually acted quite independently from its parent, but such a defence has so far never been accepted by the EU Courts.
Secondly, the EU Courts have accepted that, where the infringing company is a joint venture, parental liability can be applied to both joint venture partners, allowing for the strange reasoning that the joint venture acts as a single economic unit with both of its parents (See Cases C-171/12 P Du Pont de Nemours/Commission and C-179/12 P Dow Chemical/Commission).
Thirdly, the text for an EU Directive on antitrust damage claims voted on 17 April 2014 by the EP also refers, when it comes to defining the claims concerned, the word "undertaking", which is certain to open the door for parental liability claims in private damage cases. (Please click here for the text voted by the EP).
The Parental Liability Doctrine applied to Financial Investors and Private Equity Companies
In a first step to expand its Parental Liability Doctrine to entities that participate in a company for financial reasons only, the Commission targeted financial investors.
In the Calcium Carbide Case, the Commission held Arques and 1. garantovaná, private equity companies specializing in the direct acquisition and restructuring of companies in distress, jointly and severally liable for infringements committed by their respective subsidiaries SKW and NCHZ (Commission decision of 22 July 2009 in Case COMP/39.396). Both companies argued that they acted as pure financial investors and were not involved in management decisions of SKW and NCHZ, but these arguments were dismissed by the Commission and, on appeal, by the EU General Court (Case T-392/09, 1. garantovaná a.s. v. Commission, not yet published, para. 52; and Case T-395/09, Gigaset AG v. Commission, not yet published), para. 26 a.f.).
Arques argued that it focused on strategic and restructuring decisions and did not engage in portfolio company business decisions, because it lacked the know-how to do so. It did receive information on turnover, results, cash-flow, liquidity planning and it monitored the restructuring process, but did not consider this decisive influence. The Commission and the General Court, however, dismissed these arguments, indicating that (i) Arques closely monitored the restructuring process and (ii) the private equity company had the interests of the group in mind when taking decisions in relation to its portfolio company such as whether the subsidiary should be sold and for which price.
In earlier cases, however, investor companies have been able to escape parental liability by arguing that they behaved like pure financial investors, without actively becoming involved with the business decisions of the portfolio company (See, e.g., Commission decision of 20 October 2004 in Case COMP/38.238 – Raw Tobacco Spain, para. 383).
The next step is to look at portfolio management companies. In the Shrimp Case, in which it fined three North Sea shrimp traders for a total of EUR 28.7 million, a fourth cartel member having received immunity, the Commission refrained from imposing a fine on private equity company Gilde Buy Out Partners in relation to the behaviour of portfolio company Heiploeg (Case COMP/AT.39633 – Shrimps). It has now crossed the Rubicon in the Power Cables Case.
The Parental Liability Doctrine applied to GS Capital Partners in the Power Cables Case
GS Capital Partners V is an investment fund managed by GS Capital Partners, a full Goldman Sachs subsidiary. Under a management agreement with the fund, GS Capital Partners exercises the voting rights in respect of the fund's portfolio companies. Another Goldman Sachs entity also invests in the fund, having committed $ 2.5 billion, or 30%, of the fund's total capital.
In July 2005, the fund acquired Prysmian SA from Pirelli. In 2007, Prysmian held an IPO, reducing the shares held by the fund to 31.8%. In 2009, the fund sold its last shares.
In its decision, the Commission takes the view that Prysmian has participated in a cartel that lasted from 1999 to 2009. It applies the Parental Liability Doctrine to GS Capital Partners. Although the decision has not been made public and cannot, therefore, be analysed in detail, the Commission points at the following elements in its press release:
- During the period 2005-2007, GS Capital Partners held 100% of the voting rights in Prysmian, which enabled it to remove and nominate the board of directors at any time;
- The decisive influence is deemed to continue even after GS Capital Partners reduced its stake to 31.8% in 2007 because it still had employees, rather than representatives, sitting on Prysmian's board of directors;
- This board representation and certain voting rights still enabled GS Capital Partners to be involved in Prysmian's management decisions; and
- GS Capital Partners was regularly updated on Prysmian through monthly reports.
In his speech introducing the decision, Competition Commissioner Almunia issued a clear warning to financial investors and private equity management companies:
"I would like to highlight the responsibility of groups of companies, up to the highest level of the corporate structure, to make sure that they fully comply with competition rules. This responsibility is the same for investment companies, who should take a careful look at the compliance culture of the companies they invest in."
(Please click here for the full text of the speech.)
Open issues
This decision and similar decisions that are pending in various EU member states raise various issues.
First, GS Capital Partners will certainly challenge the question of principle whether a private equity portfolio manager (as opposed to a private equity company that invests itself in a subsidiary) can indeed be deemed to operate as a single economic unit with the portfolio companies of the fund it manages. The company only manages the fund on behalf of the investors. It may exercise certain voting rights in order to protect the financial interests of the fund, but usually does not involved itself with core business decisions or coordinate the market behaviour of various portfolio companies.
If that hurdle is overcome, the case also raises specific issues relating to the concept of "decisive influence": was it enough for GS Capital Partners to have certain voting rights, or was the nomination of GS employees as Prysmian board members decisive in attributing parental liability? Can a distinction be drawn, in relation to the voting rights, between active voting rights requiring the portfolio manager to agree with certain decisions, and negative voting rights, enabling it to intervene in certain specific cases? Can a distinction be drawn, in terms of representation in two-tier systems, between the managing board and the supervisory board?
How can private equity portfolio management companies protect themselves?
Pending clarification of these issues, private equity firms should consider appropriate risk mitigation strategies for dealing with the antitrust risk relating to portfolio companies.
- To prevent is always better than to cure. Effective competition compliance programmes should be implemented both at the level of the private equity management company and at the level of its portfolio companies.
- Risks can also be mitigated by avoiding the near-100% area where a competition authority can rely on the rebuttable presumption that there has been decisive influence, by avoiding to appoint employees as board members and by preferring negative control rights above positive control rights.
- In the selection of potential investments, a thorough competition risk due diligence should be undertaken.
- Warranties and indemnities and other contractual provisions should be tailored to account for anti-trust risks.
- Portfolio management companies may choose to take out a separate insurance covering theses same risks.
