Nominees of private equity (PE) funds on various boards, so far treated as independent

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directors, are increasingly perturbed at the risks of civil and criminal liability that may befall them. PE funds routinely appoint nominees to the board of companies, where they pick up equity stakes, to ensure better quality of governance and protection of stakeholder interests. “We are examining the issue and rushing to take directors and officers liability insurance policy to mitigate the potential liabilities to some extent. But we cannot fully mitigate the risks. This is a big concern for the PE industry in India,” said Balaji Rao, managing director, Starwood Capital India, a PE fund focusing on real estate and hospitality.

When contacted by Financial Chronicle, Shahzaad Dalal, vice-chairman, IL&FS Investment Managers, said people are reluctant to go and join boards as independent directors. “But we have no option but to go on the board of the companies. This is the cost of doing business for us,” he said.

“Though nominees of banks and financial institutions may be considered as independent directors on the boards of companies, PE fund nominees who supply equity capital are not treated as independent. Rather, they are treated as interested directors,” said Som Mandal, managing partner, FoxMandal Little.

The private equity industry faces a Hobson’s choice in some respects; it would not like its employees to be fully exposed to liability nor would it like a situation of having no directors on the board of a company it has invested in. “The PE fund is expected to bring in standards of corporate governance, access to markets and higher operating leverage to increase the probability and amount of success. For this, we need to put appropriate people on the board and on key committees of the board such as the audit committee and corporate governance committee. We can’t hire people we don’t know to do this for us,” said Shailendra Bhandari, head —private equity, Tata Capital.

In this year alone, 340 independent directors have quit the boards of companies. As NG Khaitan, senior partner, Khaitan & Co, says, “A lot of people are shying away from these responsibilities as the provisos are quite harsh.”

The potential civil and criminal liabilities that PE fund nominees can be exposed to has increased the level of due diligence that these strategic investors do before committing their reputations to any firm, particularly small and mid cap companies. “People are slightly hesitant as they want to know the background of the company and its promoters,” said Sudhir Dash, director, Motilal Oswal Investment Advisors.

PE firms are, therfore, focusing on operating partners who are industry experts and are closely involved with the investment transaction, to represent them on the boards of the companies and help in the mission of implementing the business plans.