The growing threat of litigation and the effective management of external advisers were among the many issues sparking debate among general counsel at the Legal Week Private Equity Forum. Michelle Madsen reports

Getting to grips with a tougher regulatory climate and managing a fast-expanding roster of external advisers are two crucial issues that in-house lawyers in private equity must face.

These were also the themes of two of the mostly heavily-attended breakout sessions at the first Legal Week Private Equity Forum, held at the Landmark Hotel last month.

Playing it safe

John Aiello, general counsel of Goldman Sachs' private equity arm, and Mark Pangborn, deputy chairman of insurance broker Howden, led the session on risk. Key issues were managing the mounting litigation risks facing the industry.

The increasing prevalence of consortium bids, in which several buy-out houses club together to acquire large companies, were singled out as a major risk for any sponsor with US exposure.

One US corporate counsel flagged up such deals – particularly if they involved taking private a company with a substantial US stock listing – as the highest single risk area for any general counsel to consider.

Risk derives largely from potential competition issues or the odds of a shareholder claim from the US' notoriously aggressive plaintiff Bar.

One delegate commented: "If you have a company worth $20bn-$30bn (£10bn-£15bn) with maybe five acquirers who could possibly buy it and four of them suddenly club together, that is a problem – at least in terms of how it looks."

Commenting on the risk of litigation, the delegate added: "If you plan to take a major company private in the US you can almost expect to be sued – there is a very high risk of litigation."

The debate around competition in the US has also focused on the Department of Justice's investigation into anticompetitive practices in the industry, which was launched last autumn.

Delegates also agreed that litigation risks in the US could even extend to fundraising, with some US states that seek to invest in buy-out funds often being very quick to pursue legal claims in the event of any losses.

"Certain states are too litigious to do business with," said one general counsel. "We have walked away from states which offered us a cheque for several hundred million dollars because they are not worth the risk."

Delegates discussed the risk of fraud at a portfolio company. Previous cases have yet to make a major impact on sponsors but general counsel were advised to have robust due diligence processes in place to show that care had been taken to detect questionable behaviour.

One corporate counsel warned that this should be done on a quarterly basis, ideally by dedicated professionals with experience of running companies, rather than investment professionals or lawyers.

The UK is so far regarded as a far lower regulatory risk, despite the Financial Services Authority last year launching a review of private equity regulation.

Pangborn warned delegates that many buy-out houses were unaware of how to maximise their cover under standard insurance policies.

He said: "Policies fail because people do not realise what you need to do to make them work. Arranging insurance is easy; explaining it is hard."

Moves to mitigate risk were also discussed, with many delegates saying that having an independent board of advisers can be a real benefit.

Pangborn observed that, as yet, there have been very few insurance claims against buy-out houses. Likewise, the costs of covering sponsors has dropped in recent years.

"Where claims can be seen is at portfolio company level," he said. "However, insurance costs have dropped, so cover is not expensive."

Relationship guidance

Leading the discussion on how relationships between corporate counsel and external advisers at buy-out houses are managed were O'Melveny & Myers London head, Matthew Hudson, and business consultant, Melanie Finfer.

Hudson, previously in-house counsel at Credit Suisse and Coller Capital, said it was essential that external advisers reflect well on their in-house counterparts: "Lawyers in private equity, whether they work in-house or at a firm are much the same beast – they have to have an entrepreneurial streak. You are either entrepreneurial or you are not," he said.

Members of the group, both in private practice and in-house, said that the buy-out sector bred unusually harmonious relationships between outside advisers and corporate counsel.

There was a feeling among delegates that if private equity houses were advised by a high-profile law firm, the adviser's brand had a value in reassuring investors. This factor was cited for the very select band of firms that typically advise on fund-formation work in the UK.

Corporate counsel felt that there was a need for them to have a good relationship, not only with the lead partner on deals but also with senior associates who effectively acted as the co-ordinator for the deal.

Gemma Chinniah, legal manager at life sciences venture capital firm Mizuho International, said senior associates were often her first port of call: "I have contact with the senior associates I work with twice weekly or more. It is not cost-effective to speak to a partner all the time, so they are the people I go to if I have a question."

Delegates conceded that the fast turnarounds in the sector sometimes bred unrealistic deadlines from clients. There was, likewise, a common feeling that it was much more helpful for firms to admit that they could not do a job rather than take on a job and then not be able to complete it competently.

A typical scenario cited by a partner in private practice was being told that a deal needed to be done in a month when all those involved in it were aware that it would not be completed for two months – a situation that could only stand to weaken relationships between internal and external counsel.

"The best relationships are those in which you are open and frank all the way through a deal, not only at the beginning and end of it," said Hudson. "Transparency is very important."