Jonathan Legge

Private Capital Investment is an increasingly important component of the global financial landscape. The increasing importance of Private Capital Investment raises a number of important issues, not the least of which are insurance-related issues. In a series of three posts, Jonathan Legge, a Senior Vice President at RT Pro Exec, will be taking a look at the key insurance issues relating to Private Capital Investment. The first of the three posts is published below. I would like to thank Jon for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Jon’s article.


As noted in last week’s post on this site (here, see final item), the rise of Private Capital has continued almost unabated since the end of the financial crisis. Almost ten years into the expansion of the Private Capital business it makes sense to make sure that we have learned from the lessons of the past.  Private companies backed by Private Capital face unique risks that need to be understood and addressed by the relevant insurance professionals.


Not surprisingly, there were a number of good articles about this topic following the 2008 financial crisis when numerous Private Capital Investors (PCI) were involved in expensive litigation. A 2009 post from this blog, titled “Coordinating Insurance: Private Equity Firms and Portfolio Companies” highlighted the need for PCIs to pay attention to the coverage provided at the Portfolio Company level.


At the outset the PCI and Portfolio Company need to agree on how broadly the investor will be insured under the Portfolio Company’s policy. All properly structured policies will protect the investor as a Board Member of the portfolio company. Should coverage go further? Most likely the answer is yes. A suit against a Portfolio Company will often name the investor as an additional defendant, particularly if the investor(s) own a majority of the company. The investor is often included as they represent a deep pocket.


In situations where the investor is named as a defendant in a claim, even though they had little impact on the company beyond their role as a board member, there can be problematic allocation issues between the PCI and the Portfolio Company’s insurers.  When the Portfolio Company policy doesn’t cover the investor the Portfolio Company’s insurer can claim that a significant amount of the costs should be allocated to the PCI’s policy.


The reality is that in most cases the investors and the company’s executives will use the same counsel and pursue a joint defense. In this instance, it doesn’t make sense for the carriers to allocate between the insured parties. The potential squabbling between carriers can jeopardize an effective defense of the claims. It is preferable for the portfolio company’s insurance carrier to expressly cover the PCI for vicarious liability and preferably as a co-defendant with the Portfolio Company when they share the same counsel.


The next step is to make sure the Other Insurance section of the Portfolio Company’s policy clearly states that the Portfolio Company policy is primary to the PCIs insurance and indemnification.


A more recent article in Law360 by Ari M Berman of Vinson Elkins (here) outlines several key coverage considerations for investors. For Private Capital investors the bankruptcy of a Portfolio Company is often the biggest exposure to the Board and the PCI. For this reason, understanding how the policy will respond in a bankruptcy is a critical component of the coverage analysis. An example is the Side A coverage, which responds when the portfolio company is unable to indemnify the directors and the officers. When a company is in distress it is typically too late to amend coverage to add more side A at a reasonable cost. So ideally at inception the policy should provide the broadest available Side A coverage and if at all possible, additional limits dedicated for the executives and board members.


On a related note, all policies have some form of an exclusion for a claim brought by one insured against another insured. In the event of bankruptcy the bankruptcy trustee takes over control of the entity that has entered bankruptcy. In this scenario it is important to ensure that a suit by the bankruptcy trustee does not trigger the insured versus insured exclusion.


An emerging area of exposure for Private Capital backed acquisitions is the increased number of appraisal actions, particularly against Private Capital led transactions. According to an article in “The CLS Blue Sky Blog” (here), there were 20 transactions challenged involving Delaware incorporated target companies in 2012. In 2016 the number had risen to 48, which does not include cases that settled before the statutory 120 deadline for filing an appraisal petition.


Appraisal rights are a statutory remedy for stockholders who don’t believe that the consideration offered in a proposed transaction is sufficient. The appraisal laws differ by jurisdiction, but in general they can be lengthy and expensive for the parties involved. This is due to the fact that the statute (at least in DE) requires the court to consider “all relevant factors” in determining the “fair value”. The open ended nature of the standard allows opposing parties wide discretion in asserting the “fair value” of the business.


The risk of appraisal actions is particularly important for PCIs because many believe that PCIs are generally not willing to pay as much as a strategic buyer. It is also more common for PCIs to use a “No Shop Clause” which may be interpreted by the courts as a method to limit competition and ultimately drive down the consideration paid to the selling stockholders.


The increased prevalence of appraisal actions, particularly for PCI backed companies, makes it important to push for some coverage for the costs associated with fighting these actions.


So not only have the number of Private Capital backed companies increased, it is also clear the number and complexity of potential coverage pitfalls in structuring a management liability insurance program has increased as well. The insurance coverage procured for PCI and their Portfolio Companies needs to be coordinated and proactively managed to insure that the PCI and the Portfolio Company are adequately covered and that both sides understand how coverage will respond in various scenarios.


In our next post in this series we will focus on the appropriate coverage for PCI investors. The article will address the questions of what is the same for these investors and how coverage should differ based on the investor type. The final post in the series will look at Transactional Risk insurance and how it helps PCIs manage their exposure to deal risk.