Shareholder Representative: Not a Passive Job

When we first started SRS, we talked to a number of people who said “the beauty of your business is that there’s nothing to do on your engagements if the buyer doesn’t make a claim.” That’s not accurate and represents what we see as a pervasive misunderstanding in the market about a shareholder rep’s duties and obligations.

Under Delaware law, the fiduciary duties of a shareholder rep are analogous to those applicable to a director of a corporation. These include duties of care and loyalty. Nobody thinks that a director can do his or her job properly by being passive and not doing anything until required, but, for some reason, the business community has assumed that this is ok when serving as a shareholder rep.

Admittedly, the jobs of being a shareholder rep and director are different. When serving as a shareholder rep, there is no longer an active company that needs to be managed. However, real money is still at stake and there are several processes that need to be managed even if the buyer never makes a claim. From what we’ve seen, many shareholder reps likely fail to meet their fiduciary obligations in performing such tasks.

For instance, many reps will not do anything with the monthly bank statements they receive other than give them a quick glance and then toss them. If mistakes are made by the bank (and they are more frequently than you’d think), the rep probably failed to meet his duty of care. Similarly, when working capital adjustments are made, many reps will ask former management what they think without any further independent verification. This is often the case even if the original calculations came from former management and should be independently verified, or if management now works for the buyer and has an inherent conflict, or if those individuals are now clearly “checked out” and not interested in doing any real work. If a mistake is later discovered, the rep could be found liable for failure to satisfy fiduciary obligations.

The typical rep doesn’t do this because he or she is lazy. We’re generally talking about type-A personalities who didn’t get to where they are by being reactive. They generally take the passive approach because (i) they often never wanted the job of being the rep in the first place, and (ii) most of these individuals already have a day job that takes 80+ hours a week of their time.

The rep also has a duty of loyalty to all of the former stockholders. When the rep is an individual who works for one of those former stockholders, there is an inherent possible conflict of interest since that rep has a direct personal interest in any claims or issues. While those interests are often aligned with the other former stockholders on many of the issues that may arise, there can be no comfort that this will universally be the case. Even if the rep does his or her job in good faith to the best of their abilities, there is a risk that another stockholder could try to grab onto this inherent possible conflict and use it as a basis of a claim that the rep was treating some stockholders more favorably than others.

The point of all of this is that the notion that there is “nothing to do unless buyer makes a claim” is simply wrong. The job, if done correctly, is hard even in the absence of any claims. If claims are made, it just gets considerably harder. Taking the “nothing to do” passive approach can be pretty risky. This is especially true since most reps perform the job in their individual capacity, which is in contrast to just about everything else they do in the scope of their profession.