Preferred General Partnership Liability (“GPL”) Policies for Private Equity Firms

Preferred General Partnership Liability (“GPL”) Policies for Private Equity Firms

By David Gauntlett*

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The general partnership liability (“GPL”) policy combines directors and officers and professional liability policies. The key elements of protection provide investment firms and their managers, officers, and directors as well as extend coverage of the investment firm to portfolio companies they manage.

What GPL Policies Do and Do Not Cover

Lawsuits against private equity firms frequently arise after an M&A transaction often alleging a flawed sale process by directors and officers that breached their duty of loyalty, good faith, and full disclosure to their company. Should Fiduciary Breach claims arise, GPL policy cover all legal fees and expenses associated with these shareholder actions.

Challenges to insurer include:

1.??????Minority shareholders or limited partner claims of firm mismanagement of monies;

2.??????Neglect or claims addressing oversight;

3.??????Incomplete due diligence or conflicts of interest; or

4.??????Insolvency in portfolio companies that extend to fiduciary duty or fraudulent conveyance claim

5.??????Government investigations, or enforcement actions by federal or state regulatory agencies (e.g. U.S. Securities and Exchange Commission, U.S. Department of Justice, Consumer Financial Protection Bureau, and US attorney’s offices and state attorney general);

“Bump-up” Exclusions Limit Coverage in GPL Policies

“Bump-up” exclusions bar coverage for claims alleging inadequate consideration paid (a “bump-up” in purchase price). The forms of language used to express this concept are diverse. “Bump-up” exclusions more often involve claims against a purchaser for paying inadequate consideration. “Bump-up” exclusions, however, can apply to claims by shareholders of an acquired company that were not adequately compensated for their shares.[1]

Coverage for Managers Under GPL Policies

GPL policies for private equity firms can extend coverage for managers of outside companies in which the equity firm invests. “Double excess” provisions within D&O policies extend coverage for a firm’s Directors and Officers in conjunction with an outside firm. Using “double excess”, GPL policies protect outside directors or managers if there is no indemnification or insurance available for the outside entity.

GPL policies work in conjunction with coverage polices of the private equity firm and the outside firms in which they invest offering multiple pathways of recovery. Endorsements can address issues that arise when firms lack indemnity exposure. Under “Other Insurance” provisions in D&O policies, a firm’s GPL policy functions in excess.

The policyholder may be unable to pursue a lawsuit in court because mandatory arbitration or other dispute resolution provisions may be the requisite pathway to exhaust before a lawsuit can be pursued. Policyholders can lose benefits to choose where they will pursue a lawsuit by “choice of forum” or “choice of law” selections in a policy which subject them to litigation under a particular state’s law that may prove more favorable to an insurer. Selection of the forum that has no relationship to the dispute between an insurer and a policyholder may not be enforceable in some jurisdictions which include California. Thus where an LLC or corporation resides is often the preferred forum. One solution to a disagreement on this issue can be adoption of a neutral forum for adjudicating coverage issues such as Delaware. Where one party is a Delaware LLC or corporation, that selection, itself, will cement the application of Delaware law to the coverage dispute. [2]

Ongoing Review of GPL Policies

Diligent monitoring of policies as they are procured, modified and renewed is critical. The following issues should be evaluated in connection to those activities:

1.??????Coverage for funds and private equity affiliates if sued as co-defendants due to their ownership in or management control of the portfolio company

2.??????Contractors’ indemnity provisions and the consequences of a firm insolvency

3.??????Policyholder’s coverage capacity

4.??????Company risk profile changes requiring re-visitation of new or changed limits or sublimits

Other Coverage to Complete Protection under GPL Policy

·??????Errors and omissions coverage – professional liability claims from the rendering or failure to render professional services

·??????Media insurance (often sold with Cyber)

·??????Cyber Insurance

·??????First and Third-party policies (e.g. property and business interruption coverage, general liability coverage, workers’ compensation coverage)

Valuable Benefits Attached to Securing GPL Coverage Beyond that available in D&O Policies

Private equity partnerships may not locate the appropriate coverage under standard D&O policies. The preferred route for private equity firms is securing specialized coverage policy’s like a GPL policy as well as the other referenced policies above to obtain coverage for both management and professional liability exposures as they encompass coverage for claims often arising from private equity partnership disputes. ?

A federal district court applying California law, in XI Specialty Insurance Co. v AIG Specialty Insurance Co.[3], determined that a D&O policy was the primary coverage while a Management and Professional Liability Policy (analogous to a GPL policy) was held to have subrogation rights against the D&O policy. This result arose because the D&O policy was the “primary” policy while XI was excess to a more complex policy structure which included Management and Professional Liability.[4] A private equity firm securing a GPL policy at lesser cost than required to obtain a D&O policy might well realize appropriate policy benefits for addressing “breach of fiduciary duty” claims arising in fact scenarios like that in XI Specialty which addressed the unlawful distribution of loan proceeds.

D&O policy exclusions that function to bar coverage for claims “arising out of” policyholder interactions with “outside entities” and their directors and/or officers can be effectively insured through GPL policies. The court’s favorable ruling in XI Specialty Insurance Co. v. AIG Specialty Insurance Co. flowed from its narrow construction of exclusionary language[5] rejecting prior case authority. [6] In so ruling, the court concluded that the “arising out of” provision in the exclusion was limited to the “director defendants [acting] in their capacities as Pacific World Directors only.”[7] Thus the “arising out of” exclusionary language did not extend to bar coverage for other executives.[8] ?This analytic approach was predicted by a recent decision from the Ninth Circuit Court of Appeals.[9]

Conclusion

Private equity companies may benefit from securing GPL policies as they combine the best features of D&O and CGL policies sold to private equity partnerships. Where entities include Directors and Officers or members of LLC’s obtaining a GPL policy may best be supported by procuring a D&O policy. The intersection between GPL and D&O policies is a critical element in structuring the broadest possible portfolio of pertinent insurance for private equity partnerships.

*David A. Gauntlett is a principal of Gauntlett & Associates. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com. ?

[1] Onyx Pharmaceuticals Inc. v. Old Republic Insurance Co., No. CIV. 538248, at 33-34 (Cal. Super. Ct. Oct. 1, 2020) (When shareholders breached their fiduciary duty by failing to sell Onyx for its highest price, Onyx Pharmaceuticals was obligated to indemnify their directors and officers without reimbursement as the claim falls into the “Loss Exclusion” [bump-up exclusion] of their D&O policy.)

[2] RSUI Indem. Co. v Murdock, 248 A.3d 887, 895-896 (Del. 2021) (“Dole’s status as a Delaware corporation” was determinative in the court’s view as to what law would apply because under Delaware law “the insured’s state of corporation is the dispositive factor in choice of law for D&O policies.”)

[3] XI Specialty Insurance Co. v. AIG Specialty Insurance Co., 2021 U.S. Dist. LEXIS 143270 (C.D. Cal. 2021)

[4] Id. at *20 (The court required AIG to function as the “primary” insurer because XI Specialty which was excess to the “Steadfast policy” had subrogation rights against it under its “Other Insurance” provision. Thereby ruling that the Management and Professional Liability policy (Steadfast policy) where the rights thereunder superseded those of the broader more diffused and less clearly applicable D&O policy that was procured in conjunction with the D&O policy.)

[5] Id. at *53 (“Under California law, ‘policy exclusions are strictly construed.’ [citing, E.M.M.I. Inc. v. Zurich Am. Ins. Co., 32 Cal. 4th 465, 471 (2004)]” and as such, “a policy’ exclusions should be interpreted narrowly against the insurer. [citing ?MacKinnon v. Truck Ins. Exch, 31 Cal. 4th 635, 648 (2003)]”)

[6] Id. at *54, (“[A] broad interpretation to the terms ‘arising out of’ or ‘arising from’… broadly links a factual situation with the event creating liability, and connotes only a minimal causal connection or incidental relationship. [citing ?Acceptance Ins. Co. v. Syufy Enter., 69 Cal. App. 4th 321, 328 (1999)]”)

[7] Id. at *56

[8] Id. at *60 (The language of the [exclusion] does not address “when liability arises from actions taken by covered executives in a covered and non-covered capacity.”)

[9] My Choice Software, LLC v. Travelers Cas. Ins. Co. of Am., 823 Fed. Appx. 510, 512 (9th Cir. (Cal.) Aug. 19, 2020) (“Applying the "arising out of" exclusionary language to the allegations asserted in the Trusted Tech cross-complaint runs counter to the principle that. . . exclusionary clauses are interpreted narrowly against the insurer.") ?see also, David Gauntlett, Reach for the Stick: Why Dynamite is Less Dangerous Than “Claims Made and Reported” Policies. Gauntlettlaw.com (2021)