Designated law firms in private equity deals – risks and implications for lenders and PE sponsors
In complex leveraged loan transactions—particularly those governed by English law credit agreements—a growing trend sees private equity (PE) sponsors designating law firms to represent lenders. Even where the credit agreement is governed by English law, financing may be directed toward the acquisition of Swedish companies. Some Swedish law governed credit transations also reflect this trend, with sponsors selecting the law firm for lenders.
A recent analysis by researchers Yijia Zhao, Douglas Cumming, Ruiyuan Chen, and Binru Zhao, published on the Oxford Business Law Blog examines this phenomenon and suggests that it may have unintended consequences for PE sponsors who appoint law firms to represent lenders. The study is available here.
Key Insights from the Oxford Study The research highlights that while PE sponsors may benefit from efficiencies by selecting designated law firms, this practice could paradoxically lead to less favorable loan terms for the sponsors themselves. The analysis suggests a potential conflict of interest: when lenders are represented by firms chosen by the PE sponsor, their legal counsel may appear more aligned with the sponsor’s objectives than with protecting the lender’s interests. This perceived misalignment could lead to lenders imposing higher loan prices or stricter terms due to their potential concerns regarding the neutrality of their legal advisors. Additionally, when lenders plan to syndicate rather than retain the loan, the PE sponsor may receive more favorable terms in the short term, but this dynamic may ultimately challenge market stability to the detriment of the borrower and the sponsor. The researchers caution that the impartiality required to sustain trust between lenders and borrowers ultimately may be compromised as a result of the practice of designating law firms.
Legal Impartiality Concerns The study also sheds light on the broader implications for legal practice. On that note, for Swedish Bar Association members, impartiality is not just a standard; it’s a requirement. Lawyers must prioritize client interests—specifically, those of the lenders—even if designated by the opposing party. When PE sponsors select law firms with whom they have established relationships, or when firms seek to be designated for future engagements, there is an apparent risk that these firms may, intentionally or not, prioritize sponsor interests over those of their client. Such an alignment could challenge the objectivity demanded by the Bar Association guidelines, potentially impacting lenders’ decision-making, as they reasonably depend on impartial counsel to safeguard their investments.
Market Impact and Emerging Trends Currently, PE sponsor influence on law firm designation is more prevalent in English law governed credit agreements, but such agreements from time to time involve Swedish lenders and target companies. Moreover, similar practices have been observed in connection with Swedish law governed credit agreements and pure Swedish circumstances. If this trend gains ground, Swedish lending standards may be affected, and PE sponsors may face heightened scrutiny regarding their relationships with legal counsel. Lenders, in turn, might become increasingly cautious about the capacity of designated firms to offer unbiased representation.
Looking Ahead: Encouraging Balanced Representation As stakeholders navigate these challenges, reconsidering designated law firm practices could benefit PE sponsors, lenders, and law firms alike. By fostering a more balanced approach, PE sponsors may streamline transaction processes without compromising the quality and impartiality of lender representation. Ensuring that lenders feel fully represented could, in the long run, reinforce relationships in the leveraged finance market and uphold Swedish lending standards and bolster a liquid market for lending.
