Directors & Officers Insurance for Private Equity Firms
Author: Kyle Muscat
Private equity firms often view D&O coverage as an essential risk transfer mechanism used to insulate the firm and their executives from financial loss. In this article we will discuss what D&O coverage is, why it is important and how one would go about obtaining a policy.
Why does a private equity firm need D&O insurance?
It is well known that incorporation creates a legal business structure separate and individual from its owners. This legal entity separation allows the corporation to carry its own obligations and liabilities.
What is less known is that individuals within the corporation may still be held personally liable for the decisions they make within the company. This exposure to personal liability is the principal reason why organizations should carry D&O insurance.
How Does a D&O policy work?
As noted above, a D&O policy protects a firm’s directors, officers and senior managers from personal financial liability should they be sued for alleged mismanagement in their appointed capacity. The policy itself can be broken out into (3) primary forms of coverage, including:
Side A Coverage – Personal Liability:
Side A protects individual directors and officers against losses that the firm is not able to indemnify. These losses may include defense and settlement costs that the individual director or officer is personally liable to pay.
Side B Coverage – Corporate Reimbursement
This insuring agreement reimburses the organization for any costs incurred while defending their directors or officers as per their indemnification obligations. Side B responds most often in the majority of claims and offers balance sheet protection to the organization.
Side C Coverage – Entity Coverage
The Side C insuring agreement provides entity-related coverage to the organization when it is named in a suit alongside the directors and officers.
Outside Directorship Coverage
It is not uncommon for PE firm executives to sit on the board of the portfolio companies in which they invest. This does however expose these executives to additional personal liability. Fortunately, D&O polices can be designed to include Outside Directorship coverage. Essentially, this can be viewed as portfolio company D&O, protecting the firm’s executives in their involvement with related companies.
How often do D&O claims arise?
Even the most prudent fund managers may find themselves on the receiving end of a lawsuit. This holds especially true given the number of stakeholders involved and complex nature of M&A transactions – only further compounded by the increasingly litigious environment within North America.
It’s important to note that in most instances the policy will respond to cover defense costs regardless of whether damages have been substantiated in the courts.
Examples of D&O claims:
- Misappropriation of fund assets
Limited partners of a private equity fund allege improper fee disbursements to the fund manager. This leads to a civil litigation and a suit for the restitution of fees collected.
- Breach of contract and fiduciary duty
A private equity fund underperforms expectations due to a poor performance in one of its portfolio companies. While the loss may be due to economic factors, a few of the investors allege it was a result of poor decisions on behalf of the general partners. The limited partners then file a suit alleging breach of contract and fiduciary duties in the management of their investment.
- Defense of a Books and Records request lawsuit
An investor of a fund files a suit against the firm alleging that it failed to comply with their demand for the inspection of books and records. While the firm then provided the required documentation, defense costs of $80,000 were incurred in response and management of the suit.
- Defense of a CSA investigation
A private equity firm received a Subpoena and a Civil Investigative Order from the Canadian Securities Administrators (CSA) requesting documents in connection with an investigation being conducted. While the firm has agreed to cooperate in the investigation, defense costs incurred in this matter could quickly balloon depending on their findings.
How much does a D&O policy cost?
The above question is one we are asked often. The cost of a D&O policy is however highly contingent on the particulars of one’s operations. Each firm is unique, and a number of factors are considered when underwriting the policy. This includes;
- Firm size & revenue
- Ownership structure
- Financial performance & capitalization
- Claims history
- Industry(ies) of focus
- # of Funds & average fund size
- Investor composition & more…
Given the wide range of variance between PE firms, there is no set “price” for any one policy. Antidotally, we would comment that premiums typically range anywhere from $10,000 to $100,000 per $1M of coverage limit. This of course is highly dependent on the factors noted above.
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Whether you are approaching a renewal or obtaining private equity D&O coverage for the first time, it is imperative that PE firms partner with an experienced insurance professional who understands the nuisances of your business. Our dedicated private equity practice works with all major insurers in Canada and abroad – offering a comprehensive market view at the most favourable terms possible.