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As Litigation Risk Increases, Private Equity Sponsors Should Re-Evaluate Their Professional Liability Insurance Programs

Private equity fund sponsors are facing increased litigation risk from regulators and private parties, including limited partners and stakeholders in portfolio companies.  As a result, private equity firms should re-examine their professional liability insurance policies to ensure that their coverage is properly aligned with this increasing risk. 

Simply put, private equity sponsors must treat their professional liability insurance as a critical risk-management component of their business.  Most, if not all, private equity fund sponsors have some form of a professional liability program in place, typically in the form of a general partner liability—or “GPL”—policy.  In many cases, these policies are “off-the-shelf” and are not sufficiently tailored to meet a particular fund sponsor’s specific business needs or risks, particularly as litigation and regulatory risk continues to increase.

In reviewing GPL coverage, these are some of the key questions:

Are activities by regulators covered “claims,” and if so, what specific types of activities are covered by the policy?  Given the intensifying scrutiny of private equity by the SEC and other regulators, fund sponsors should consider obtaining insurance coverage for regulatory investigations, enforcement actions, and other activities.  If such coverage is in place, sponsors also should conduct a cost-benefit analysis based on whether the coverage is triggered only by certain “formalities” of the enforcement process (e.g., receipt of a Wells Notice or subpoena from the SEC).  Often, responding to a regulator’s “informal” or “voluntary” requests for broad categories of a general partner’s or management company’s emails—which is not uncommon—can cost well into the six-figures.

Are the “insured versus insured” exclusions from coverage too broad?  Professional liability policies typically exclude from coverage claims brought by one insured against another insured.  In the private equity context, however, it is essential that these exclusions not negate coverage for claims by limited partners against the general partner or the management company.  In assessing this risk, it also is important to consider whether “derivative” claims brought by limited partners on behalf of the fund are “insured versus insured” claims that are excluded from coverage.  Furthermore, sponsors should consider adopting a policy with express language stating that whistleblower actions are not excluded “insured vs. insured” claims.

Is there a clear order of priority between and among insurance policies and indemnification rights?  Sponsors should also evaluate the “priority” of the GPL coverage relative to other insurance coverage, whether at the portfolio company level or the management company level, as well as the priority of the insurance coverage relative to indemnification obligations of the fund (i.e., the limited partnership that the sponsor advises), the management company, and the portfolio companies.

A comprehensive review of a professional liability insurance program may uncover numerous other issues including, for example, vague “conduct” exclusions from coverage for things like “dishonest acts” or violations of “public policy” by insureds, or a definition of “defense costs” that does not include work performed before a lawsuit is filed.

As a more general matter, sponsors also should consider whether insurance coverage is appropriate for the limited partnership that the sponsor advises (in addition to coverage for the general partner, the management company, and their affiliates).

There are many other potential pitfalls to consider.  For the sake of brevity here, suffice it to say that what may appear to be very minor drafting decisions can have real and significant effects on the scope of the coverage, and we recommend that private equity sponsors work with insurance brokers and outside counsel who are familiar with the private funds industry and insurance issues in assessing their existing coverage.

© 2021 Proskauer Rose LLP. National Law Review, Volume V, Number 317
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About this Author

Joel Cavanaugh, Private Investment attorney, Proskauer law firm
Associate

Joel Cavanaugh is an associate in the Litigation Department and a member of the Private Investment Funds Disputes practice. Joel's practice focuses on litigation involving private investment funds, including private equity, venture capital, and hedge funds. He also has experience in a broad range of complex disputes in the areas of intellectual property, antitrust, securities, and mergers and acquisitions.

617-526-9651
Timothy W. Mungovan, Litigation Attorney, Proskauer Law Firm
Partner

Timothy Mungovan is a Partner in the Litigation Department, co-head of the Private Investment Funds Disputes practice and a member of the Private Investment Funds Group. Tim has an international practice in complex commercial litigation, advising public and private companies in a variety of areas, including securities, corporate governance, fiduciary obligations, investment management and financial services, fraud and trade secrets.

In addition to his regular commercial litigation practice, Tim focuses on disputes involving private investment...

617-526-9412, 212-969-3201
Michael R. Hackett, Litigation Attorney, Proskauer Law Firm
Associate

Michael R. Hackett is an associate in the Litigation Department and a member of the Asset Management Litigation practice. His practice focuses on disputes and regulation involving private funds, including private equity, venture capital, hedge, real estate and private credit funds, as well as other limited partnerships, where he regularly advises funds, fund sponsors, investment advisers and institutional and individual investors.

Mike’s experience representing private fund clients runs the gamut, from control contests within advisers, to...

617-526-9723
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