BusinessToday Previous Editions

5.12.19 12 David Birchall & Nadia Bernaz OPINION 25.5.2023 David Birchall is Senior Lecturer in Law, London South Bank University Nadia Bernaz is Associate Professor of Law, Wageningen University Private equity: when big profits come at a heavy price for human rights P rivate equity is an enor- mously powerful and wealthy industry that has a huge impact on the pub- lic and their human rights. As a sector, it holds around US$4.4 trillion (£3.5 trillion) in assets, while in the US, one in every 14 workers is employed by a company owned by a private equity firm. These firms use a unique business model. They attract outside investors by promis- ing high returns, and invest this capital in buying compa- nies. The aim is to make these companies more profitable, return the necessary gains to their investors and then sell the company, usually around five years later. Recently there has been an increased appetite for pri- vate equity firms to buy com- panies that provide services such as health and social care, detention facilities and hous- ing – services often relied on by vulnerable people. Those people – and the workers who provide the ser- vices – are directly affected by some of the tactics used by private equity firms to make money, such as cutting staff and other running costs. Other ways of raising funds quickly include "leveraged buyouts", where the purchase price of a company is partly funded by a loan taken out against that company. Anoth- er common method is "divi- dend recapitalisation", which means borrowing to pay in- vestor dividends. But these strategies – known as "value extraction" when they deliver investor returns by weakening the company – often lead to unsustainable debt levels and poorer qual- ity services. This in turn can have a damaging effect on people's lives and a significant impact on their human rights, including employment rights and the rights to health and housing. In the US, for example, many hospitals bought by private equity firms have been ac- cused of drastic cost cutting, leading to persistent mechan- ical breakdowns, a lack of medical supplies, and insuffi- cient fuel for ambulances due to unpaid bills. A study found that private equity ownership increases the "short-term mortality" (deaths in care and during the following 90 days) of Medicare patients by 10%. In the UK, two of the larg- est nursing home chains collapsed following private equity takeovers (Southern Cross in 2011 and Four Sea- sons in 2019), leading to job losses and closures. Research also suggests that workers in private equity owned nursing homes earn around 30% less than they would in a home run by the government. The private and the public The tactics built in to the private equity business mod- el directly affect people's lives and human rights. So human rights governance needs to address these tactics directly. Our recent research suggests that an area of law known as "human rights due diligence" could provide a solution. Al- ready in place in France, Ger- many and Norway, these laws require companies to identify the human rights risks with- in their operations. ey then need to investigate and miti- gate these risks, with a legal ob- ligation to cancel a project or activity if the risks are too high. There are already specific human rights standards ap- plied in sectors such as min- ing, farming, fast fashion and factory manufacturing. If a company sources from a fac- tory, for example, it should ensure there is no child la- bour involved. Applying the same approach to private equity firms is rath- er different, because some- thing like the act of borrowing a large sum of money to pay dividends does not directly vi- olate human rights in the way that factory operations might do. It is instead the debt and cost cutting made necessary by the loan that could lead to understaffing and poor levels of care, which can then vio- late human rights. But just because it is differ- ent does not mean it is im- possible. Human rights laws already apply to bank lending, and the economic activity of private equity firms should also be covered. The technique would be fairly simple. A private equity firm undertaking any form of value extraction from a com- pany it owns should identify how that undertaking will af- fect how that company is able to meet its human rights obli- gations. If no subsequent ef- fect on human rights is found, it may proceed. However, if an effect is like- ly, the size of the debt raised or the dividend paid out to in- vestors should be reduced to the extent that human rights are left intact. The law would be able to punish any firm that failed to conduct ade- quate human rights due dili- gence. Such a move would help to ensure that human rights are respected more widely. Across the world, those rights are routinely affected by eco- nomic activity – and as the impact and wealth of private equity firms continue to grow, legal enforcement would offer better protection for all of us.

• Cover