Managing PE risk
HOW PORTFOLIO COMPANIES RESPOND TO CRISES IS A MAJOR CONCERN
GREG DILLARD, KATTEN, MUCHIN & ROSENMAN LLP, HOUSTON
Private equity firms frequently take an active role in managing their portfolio companies through board and advisory services. And while private equity firms design their operations and investment structures to limit risk, some fail to ensure that their investments have limited their own risk by being prepared for the multidisciplinary challenges of a major incident. To meet the private equity firm's duty to manage its portfolio to maximize stakeholder value, the private equity must understand the risks and needs of the portfolio company in the event of a crisis.
Despite extensive precautions, in the high-risk energy industry, it is a matter of when not if an accident occurs. Incidents far less dire than the Deepwater Horizon incident still bring increased regulatory scrutiny, attract expensive lawsuits, and inflict severe reputational and business damage.
These incidents present a myriad of challenges that can overwhelm even the most sophisticated organizations; much less a leanly staffed operating company. A swift and sure response to multiple challenges, often simultaneously, is necessary. Woe to the operating company that lacks both a crisis plan and experienced legal counsel who knows how to respond. And woe to the private equity that does not know how to make the right legal response, especially when the operating company may rely on the private equity firm to advise on its legal resources.
For an energy company responding to a crisis, the first hours are the most critical. Poor planning and crisis management can have devastating reputational and legal consequences. Private equity firms would be wise to evaluate how prepared are its investments. This reality means that a private equity firm should ensure its energy portfolio company not only has a risk management plan but also has evaluated when it needs external resources to respond to the wide spectrum of risks it will face after an incident.
Robust crisis management minimizes risks for the portfolio company, as well as the private equity firm itself, in the wake of a crisis. But a practical limitation on emergency response plans is that the people implementing them are not experienced in crisis response; they are experienced in running the business.
Let's review some case studies to evaluate how prepared are portfolio companies and their private equity investors.
CASE STUDY 1: FIRE AT A TERMINAL
Local television news is showing video of a large fire, still billowing smoke, and reporting there may be multiple employees injured at an oil terminal in Louisiana. The plant's emergency response team reports that the fire is contained and all injured workers have been taken to the hospital. Now that the site has been deemed safe, is the terminal prepared to manage the critical business and legal risks it faces? Or will the terminal be overwhelmed, losing value and incurring additional liabilities; potentially resulting in the need for additional funding?
Imminently, three regulatory agencies arrive on site within the first few hours: the federal Occupational Safety and Health Administration (OSHA), the federal Environmental Protection Agency (EPA), and the Louisiana Department of Environmental Quality (DEQ). While OSHA is focused on employee safety and EPA and DEQ are investigating potential environmental violations, each agency requests to interview the same 10 eye-witnesses and each has issued an evidence preservation notice requiring that no equipment can be modified. The operating company must assure that no agency feels stymied or stonewalled, which could lead to unwanted scrutiny. In this situation, the operating company needs to negotiate a legal evidence preservation agreement with all three agencies while simultaneously coordinating interviews. It is really unfair to expect a terminal manager or supervisor to properly prepare employees for these interviews. Certainly, an unwanted development would be portfolio employees implicating the private equity in operating decisions. Most emergency response plans don't address whose responsibility it is to complete these critical duties.
Another challenge facing the terminal is dealing with the local news. Is the terminal manager trained and prepared to stand before a live TV camera? What if the manager is on vacation? How should the manager answer questions about the private equity investor? An inaccurate or misleading statement, even an inadvertent one, could create problems. Today, media training for management personnel should be mandatory and having previously prepared with legal counsel to recognize thorny questions is the best practice.
CASE STUDY 2: CYBER-ATTACK ON A PIPELINE
A director at a private equity firm is also a board member of a midstream pipeline portfolio company. She has received a text message from the COO of the pipeline company that a valve to the atmosphere was improperly opened and crude oil is flowing into a nearby drainage ditch. The COO spoke with the company's IT manager who thinks their operating system may have been hacked. Software for security camera equipment was recently updated at the control board facility, and this was believed to allow hackers access to the pipeline's controls, which were used to disrupt the pipeline. Beyond the likelihood that a cyber-attack may have caused the incident, the COO is concerned that the hackers stole private employee information.
Due to these reports, in addition to the environmental and pipeline regulators arriving on scene, the FBI and the Department of Justice (DOJ) are investigating the incident and the threat to critical infrastructure. Consequently, the operating company must be prepared to identify any breached computer networks and isolate them. Computer files and systems should not be destroyed. Further, nearly every state requires notifying affected customers, unless that notification would impede a law enforcement investigation. Private equity firms should evaluate whether their portfolio companies have already performed an assessment of its cyber-vulnerabilities.
Simultaneously, the pipeline company is under heavy pressure to resume operations as it is the main supplier to an entire region for oil and gas. The multiple government agencies on site are stressing the need for inspections of large sections of the pipeline. Crisis counsel can assist in addressing regulator expectations while the operating company focuses on how to return to operations as soon as possible.
Another challenge facing the COO and the board member in this scenario is how to share information between the portfolio and the private equity investors. Without experienced counsel, it is easy to disclose damaging information when communicating with private equity investors. Simply copying an attorney for the portfolio company on emails is unlikely to retain privilege over the communication.
CASE STUDY 3: INJURY AT A FRACKING SITE
A fracking company has experienced a fatality incident at a rural site in the western half of the Marcellus Shale play. Drilling equipment malfunctioned, causing a small explosion at the well site. One employee and one contractor have been fatally injured.
As with the other scenarios, regulators will quickly be on-site. But, here, the company is faced with additional legal problems, including how to conduct an internal investigation when there are no less than six contracting companies on site and the crews of each company are staying at different hotels one hour from the frack site. When can witness statements be taken? What questions need to be asked? What type of pressure monitoring data needs to be collected? And how should the fracking company respond to requests from the well owner for a copy of the company's internal investigation report?
Due to the contractor death, the operating company must also prepare for a personal injury lawsuit. Most companies have insurance to protect against such claims. But there may be less foreseeable "costs" involved with a shoddy internal investigation, such as increased scrutiny by the well owner. The owner could subsequently demand new indemnity agreements or make a request to purchase more insurance.
Finally, due to the remote location, media is a lesser concern. But reports on social media are starting to blossom, especially among the young workers on the company's field crews. It is paramount for the operating company to be prepared for how to communicate with its employees, just as much as with customers and clients. Even a seemingly benign admission on social media could result in an unintended legal liability for both the company and its private equity firm. Be sure that operating companies are considering all facets of crisis communications.
FINAL THOUGHTS
A private equity firm intentionally constructs a corporate structure that limits its investors' risk; it should ensure that its oil and gas portfolio companies have similarly prepared themselves for managing a major crisis. Only by ensuring operating companies are well-prepared for the (inevitable) future crisis, has a private equity firm managed its risks.
ABOUT THE AUTHOR
Greg Dillard is a partner at Katten, Muchin & Rosenman LLP. He has responded on-site and advised companies with regard to more than 40 fatality and process safety incidents. His practice focuses on the oil, gas, and chemical industries. Dillard advises operating company executives on a strategic level and simultaneously assists on-site with the tactical decisions when responding to an incident.