Recent Developments in Acquisition Finance

September 20, 2018

In an overlooked aspect of the recent New York Court of Appeals decision in Cortlandt St. Recovery Corp. v. Bonderman1, New York’s high court has allowed direct claims to move forward against two private equity firms for the debt of their portfolio company under a bond indenture. The decision found that the two required elements for the direct claims were asserted sufficiently in the complaint in order to avoid dismissal, namely (i) that the private equity firms controlled and “dominated” the affairs of the portfolio company and (ii) that the portfolio company’s redemption of their equity “perpetrat[ed] a wrong or injustice” or “otherwise resulted in wrongful or inequitable consequences.”2

Asserting “inequitable consequences” of equity redemption by “dominated” portfolio company found sufficient for bond trustee to proceed directly against PE firms 

The decision has been widely discussed for its holding confirming an indenture trustee’s broad standing to pursue all available remedies against an issuer and its affiliates so long as it is doing so on behalf of all bondholders under the related indenture. Less discussed, however, has been its holding and rationale with respect to the standards for potential liability of private equity sponsors for the debt of their portfolio companies. A private equity firm typically will control the affairs of its portfolio company through the latter’s board or other governing body, and will cause, indirectly through its director designees, actions to be taken at the portfolio company that benefit it, the private equity firm, as its owner. Will certain actions later be challengeable, when viewed in hindsight, as unfair to other stakeholders? And, if so, will a private equity firm potentially be liable for the debt of its portfolio company on an “alter ego” or “veil-piercing” theory? This decision, from New York’s highest court, will be looked to by courts in any jurisdiction interpreting claims under debt instruments governed by New York law, an extremely common governing law for debt instruments.3


In 2005, two private equity firms (Sponsors) acquired TIM Hellas Communications and its subsidiaries (collectively, Company), Greece’s third-largest cellular telephone provider, which prior to the acquisition had about a 20% market share in Greece’s mobile phone market, over €110 million in annual profits and a modest €187 million of debt. The acquisition transactions resulted in the Company’s incurring long-term debt of about €1.6 billion, as compared with shareholder equity of only about €38 million and, by mid-2006, its long-term debt increased to €1.94 billion, with shareholders equity dropping to just €11.4 million. In late 2006, the Company issued €200 million in PIK notes to bondholders under a New York law-governed indenture (PIK Notes). Proceeds of the PIK Notes issuance were combined with other cash on hand at the Company to redeem for cash certain preferred equity instruments held by the Sponsors, with the redemptions totaling about €973 million in cash. In 2007, the Sponsors sold the Company to another investment firm at a price of €3.4 billion, consisting of €500 million cash and the buyer’s assumption of the Company’s €2.9 billion in debt then outstanding. With the onset of the global financial crisis, the Company struggled and ultimately defaulted on the PIK Notes and went into insolvency administration in the United Kingdom in 2009. 

The indenture trustee under the indenture governing the PIK Notes brought an action in New York state court against the Company and the Sponsors. The complaint alleged that the Company’s transactions were simply a scheme intended to “bleed-out” money from the Company and into the Sponsors by “paying out unlawful dividends – even though the Hellas Group was in considerable debt”.4 The complaint asserted causes of action for breach of contract and fraudulent conveyance, among others, and included claims directly against the Sponsors on an “alter ego” theory, asserting that “piercing the corporate veil” was appropriate under the circumstances alleged in the complaint. The complaint thus sought payment from the Sponsors of the €268 million claimed to be owing on the PIK Notes together with related interest, fees and enforcement expenses.5 The trial court dismissed the complaint, but on appeal, the intermediate New York appellate court reversed, and certified the following question to the state’s highest court, the New York Court of Appeals: “[W]hether an indenture trustee may seek recovery on behalf of noteholders for defendants’ alleged fraudulent redemptions intended to siphon off assets, leaving corporate obligors unable to pay the noteholders”.6

The Court of Appeals Decision on Potential "Alter Ego" Liability 

The Court of Appeals considered carefully whether the Sponsors could be directly liable for the Company’s obligations under the PIK Notes on an alter-ego or veil-piercing theory, stating that two factors are needed for such a finding: 

“Generally, a plaintiff seeking to pierce the corporate veil must show that (1) the owners exercised complete domination of the corporation in respect to the transaction attacked; and (2) that such domination was used to commit a fraud or wrong against the plaintiff which resulted in plaintiff’s injury…. [P]laintiff bears [the] “heavy burden of showing that the corporation was dominated as to the transaction attacked and that such domination was the instrument of fraud or otherwise resulted in wrongful or inequitable consequences….“ [internal citations omitted]

It is noteworthy that the court seems to use the word “domination” pejoratively in discussing the first element of its standard for allowing potential alter-ego liability. Sponsored portfolio companies will inevitably be structured so as to enable the owner-sponsor to “control” or “dominate” its affairs. “Domination” has little legal meaning in this context different from “control,” particularly given the absence of allegations as to any failure to follow corporate formalities. Similarly, the court’s second required element -- that the control and domination was an “instrument of fraud” or “resulted in wrongful or inequitable consequences” or was used to “perpetrate a wrong or injustice” -- provides little guidance as to the particular actions that a sponsor might or might not have taken, focusing instead on outcomes and how those outcomes might be characterized or, in hindsight, recharacterized. 

Could a typical dividend recapitalization financing transaction, even with appropriate solvency comfort and respect for all corporate formalities, be challenged under the court’s standard? The court does not provide a clear answer on that score: Just how much of an equity cushion would be needed in order to avoid potential alter-ego claims? How would aggressive asset-sale transactions or other proactive moves by a portfolio company to raise needed cash (say, for working capital or capital expenditures) be viewed? And what of other transactions that fall under gray areas of its debt covenants, but that do not rise to the level at which creditors would typically call a default? Viewed with the benefit of hindsight, could these moves be viewed as “wrongful” to creditors if the extra “runway” ultimately resulted in diminished collateral or entity values available to satisfy creditors’ claims? And if so, could this mean that the rationale of Cortlandt St. would not distinguish a transaction designed to distribute cash to equityholders from one designed simply to extend a company’s runway ahead of an anticipated improvement in performance (whether due to management changes, implementation of financial or operational initiatives, industry cyclicality, or other factors)? 

A potential way to address (or mitigate) the impact of Cortlandt St. on private equity sponsors may be to include in the New York law indenture or other financing instrument a broad “no recourse” provision waiving affiliate liability. Such a provision would be similar to what is found today in a minority of indentures, providing for a waiver and release of equity holders, officers and directors of the issuer and guarantors under the financing instrument from liability under the instrument. But it would likely need to go a bit further than what is commonly covered by such provisions, so that it should cover alleged wrongdoing by a sponsor ultimately used as the basis for a veil-piercing claim against it.

Another potential solution could entail including a split-law governing law provision in the indenture or other financing instrument, which could provide that New York law will govern, other than with respect to issues of entity governance, which would be governed by the local law of the entity’s jurisdiction of formation. This may be an appropriate option in cases in which a sponsor’s advisors are focused primarily on the non-US corporate governance requirements under the local law of the jurisdiction of formation of non-US acquisition vehicles for a non-US acquisition. Inclusion of such a provision in a New York law indenture (or other New York law governed financing instrument) under which the non-US acquisition vehicles are obligated may well correspond more closely to the parties’ expectations than would subjecting the foreign entities and their sponsors to New York corporate and organizational standards, which presumably were not focused on by the parties in connection with the closing of the relevant financing transaction (as occurred in Cortlandt St.). Split governing law provisions are often included in New York security agreements involving foreign collateral, as well as in certain sovereign debt instruments, and should be unlikely to raise any material enforceability or marketing issues. 

In conclusion, it is one thing for a court to allow a claim to proceed against a sponsor as an alleged transferee of a fraudulent transfer if related federal or state law requirements for such an action are met. It is another, however, to allow a sponsor to be pursued for direct liability under a portfolio company indenture (or other financing instrument) on account of its control of its portfolio company and a perceived wrong or inequitable outcome asserted later with the benefit of hindsight. Perhaps, despite the seemingly far-reaching rationale of the decision, the actual question certified to the Court of Appeals will limit the interpretation of the decision, since it refers to “alleged fraudulent redemptions intended to siphon off assets.”8 This could limit the future application of the holding to cases where a fraudulent transfer to a sponsor is alleged to have been accompanied by the sponsor’s actual intention to impair recovery by creditors, as opposed to covering any case in which a wrong or injustice is claimed to have resulted, as the court’s discussion would indicate. Only time will tell. In the meantime, parties to such transactions will need to bear in mind these recent developments while carefully examining solvency, corporate formality, and related issues is such connection. 


1) No. 14, 2018 WL 942335 (N.Y. Ct. App. Feb. 20, 2018).
2) Id. at *8.
3) Interesting choice-of-law issues may arise concerning the appropriate law governing “alter-ego” or “veil-piercing” claims. Two likely candidates are the law of the jurisdiction of an entity’s formation and the governing law of the instrument under which liability is being asserted. The breadth of the governing law provision of the instrument will be relevant in this connection. The Court of Appeals in Cortlandt St. applied New York law to the issue, without discussion. The penultimate paragraph of this article discusses the possibility of splitting an instrument’s governing law provision in appropriate instances, e.g., when a sponsor’s advisors, in the context of a non-US acquisition and non-US acquisition vehicles, are focused primarily on meeting the non-US corporate governance requirements under the local law of the jurisdiction of formation of the non-US entities, notwithstanding the inclusion in the transaction of a New York law governed indenture (or other New York law governed financing instrument) under which such non-US entities are obligated.
4) Cortlandt St. Recovery Corp., 2018 WL 942335, at *3.
5) Id. at *3 nn.10 & 11.
6) Id. at 1.
7) Id. at *8.
8) Id. at *1.

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