Financing structures in acquisition: watch out for private liability

Except in exceptional cases, such as private surety bonds and asset conservation declarations, legal entities are almost always the primary contracting parties in acquisitions. But that does not necessarily mean that the underlying natural person directors are always out of harm's way. A good example of this occurred recently at the Arnhem-Leeuwarden Court of Appeal, in which a natural person director was successfully held privately liable. 

Financing acquisition through a money loan

In this case, a legal entity bought shares in a company, whereby the purchase price was partly converted into a money loan. As additional security for payment of the purchase price, the seller stipulated security by means of a lien on the shares sold. The deal was consummated, but almost immediately after the acquisition, the buyer defaulted on repayment of the money loan. The seller claimed payment in court and was successful. After the seller sought to enforce its lien on the shares, it turned out that the buyer had, in the interim, issued a priority share to a friendly party with approval rights regarding the dismissal and appointment of directors. Salient detail: director of the target was meanwhile the buyer. In short: as a result of issuance of the priority share, any potential buyer of the shares offered at foreclosure would be indirectly confronted with buyer. In other words: the shares had effectively become unsaleable.

Private liability

In cases like this, it is established case law that primarily only the defaulting contracting party - in this case buyer - can be sued for payment. After all, a contractual legal relationship exists with the buyer (SPA and loan agreement). But sometimes there are grounds to believe that in addition to the legal entity, natural person directors are also liable in private. The prevailing standard is that the director must have acted so negligently that he can be personally blamed for it. Judges are generally reluctant to assume the private liability of directors. This is due to the social interest in preventing directors from allowing defensive considerations to determine their actions to an undesirable extent. Freely translated: a director has to be pretty out of line if he wants to be successfully held liable in private.

Frustration of story

In this case, according to the trial court, the director had gone too far. The court accused the director in question of (i) allowing the buyer to default on its payment obligations to the seller without valid grounds and (ii) frustrating remedies by issuing a priority share while knowing that the seller was executing the first-instance judgment. 

Making commitments that are not met

The seller may have had another promising angle from which to sue the director in private, namely through the so-called Beklamel standard. In short, this means that the director is liable in private if he knew or should reasonably have understood at the time of entering into the commitment that the company would not be able to fulfill its obligations and would have no recourse. Experience shows that the degree of success of such a claim depends to a large extent on proper proof. In this case, the purchasing party should have argued - and in the event of a sufficiently substantiated challenge by the director - that at the time of entering into the purchase agreement, the director knew or reasonably should have understood that the buyer could not meet its payment obligations. In my view, the circumstance that there was a short period of time between the conclusion of the money loan agreement and the default thereon may contribute to the assumption of director liability under the aforementioned standard.

In this case, by the way, the buyer could have avoided the rather cumbersome legal regulation of enforcement of liens on shares by stipulating another form of security. For example, a private surety from the underlying shareholder or, a softer form of security, an asset conservation declaration from the purchasing company.