Leveraged buyouts and the responsibilities of management: A Dutch treat?
Rudolph Snethlage
by Rudolph Snethlage
The Estro case
Last year, the Dutch Enterprise Chamber rendered an important judgement in the so-called Estro case. Childcare chain Catalpa, renamed as “Estro”, was sold in 2010 to the American investor Providence in a leveraged buyout. The buyout was financed by means of a capital contribution to Newco (as the acquisition vehicle) by Providence of EUR 66 million, a loan of EUR 230 million by a consortium of banks, and a shareholder loan by Providence of EUR 225 million. After closing, Newco legally merged with Estro, and as a result, both the bank loan and Providence’s shareholder loan became Estro’s liability.
The entire acquisition debt of EUR 455 million – quite a heavy millstone – was hung around Estro’s neck. Estro was dependent on childcare subsidies. When a few years later Dutch government moderated the childcare subsidy program, Estro, overloaded with debt, went into bankruptcy. The receiver in bankruptcy filed a petition with the Dutch Enterprise Chamber to conduct an investigation into the policy and supervision within Estro. The legal basis for such a petition was that there should have been reasonable doubt about the proper management of the company.
This petition was successful and, on the basis of the investigation, the Enterprise Chamber determined that the members of the management board as well as the supervisory board were guilty of mismanagement because of their improper handling of the leveraged buyout. Following this court decision, the receiver has taken an important first step in holding the managing directors and supervisory directors liable on behalf of Estro’s creditors for the deficit in this bankruptcy.
Lessons learned
The grounds for the Enterprise Chamber ruling in the Estro case was that there was mismanagement. This ruling provides interesting lessons for members of management and supervisory boards when considering a leveraged buyout.
Decision-making process
Directors should carefully consider the pros and cons of a proposed leveraged buyout. A leveraged buyout should serve corporate interests and take into account the heavy financial burden which is kind of deal may involve.
Obtaining independent expert advice on the proposed transaction
In the Estro case, there were doubts as to whether management fully appreciated the nature of the subordinated loan (warranty capital, or debt?) and its potential impact on the company’s financial wellbeing. The payment-in-kind (PIK) interest was set at 15%, which even at the time of closing in 2010 was exceptionally high.
Full and correct disclosure to the Works Council
It is obligatory under Dutch law to obtain the Works Council’s advice on a contemplated transaction. This concerns not only strategic considerations, but also the way the deal will be financed. The shareholder loan was wrongfully presented as being part of the company’s “warranty capital”, and the legal merger between Newco and Estro was explained as a way to simplify the legal structure of the group. However, in fact this “debt push down” was done to comply with bank requirements.
Proactive role for supervisory directors
The headline in the Dutch Financial Times read “Supervision Is Not An Honorary Job” after the Estro ruling was published. Indeed, emphasis was laid on the lack of proactive supervision by the supervisory board members.
Final observations
The Estro case shows that management and supervisory directors should act responsibly and diligently when they are involved in leveraged transactions. Is this a typical Dutch treat? No. It follows similar (and earlier) developments in the US (the Nine West LBO case for instance), and other European countries like Germany and the UK. The standards to comply with are “the elementary principles of reasonable entrepreneurship”. These principles give management and supervisory board directors room for discretion. The Enterprise Chamber applies a marginal test. This is similar to the “business judgment rule” in the US.
GGI member firmTeekensKarstens advocaten notarissenLeiden, Alphen aan den Rijn, Amsterdam, The NetherlandsT: +31 71 535 80 00Law Firm Services
TeekensKarstens advocaten notarissen (TK) is a full-service Dutch law firm with extensive experience in the field of international law. TK has established specific international teams to provide international clients with tailor-made services and information.
Rudolph Snethlage is a distinguished expert in the field of mergers and acquisitions, advising both the buying and selling sides in business takeovers, private equity deals, joint ventures, management buyouts and buy-ins. His vast experience in M&A practice encompasses a wide range of both national and international mergers and acquisitions in various sectors. Contact Rudolph.
