Claimants looking for a big payout for perceived misconduct might be tempted to put private equity firms in their sights. Generally speaking, the private equity firms are believed to be better-funded than their portfolio companies. Private equity firms usually buy insurance coverage for themselves and their portfolio companies for losses arising from operations, such as general liability, D&O, E&O, fiduciary, crime and the like. But check the fine print. If the private equity firm shares limits with its portfolio companies, make sure there is language in the policy making clear how limits are to be applied in the event that both entities have a common loss (such as a lawsuit against both of them). Don’t wait until a claim is made to figure out which company gets paid first.
For example, suppose a shareholder of a portfolio company brings a derivative mismanagement claim on behalf of the corporation against its board. The private equity company has appointed one or more of its officers or directors to sit on the portfolio company’s board. These directors, in addition to being sued for mismanaging the portfolio company, are also sued for favoring the private equity firm’s interests over those of the constituent company. Defense costs put policy limits in jeopardy. Whose defense expenses should the D&O carrier pay first?
In the event of dwindling limits, the private equity firm probably would prefer to have its directors’ fees paid before those of the portfolio company’s board. This might be because it regards itself as having greater longevity than the portfolio company, because it has multiple businesses in play while the portfolio company has only its own. If this is so, the private equity company should make sure that its D&O policy is endorsed to state whose costs get paid first, by way of an order-of-payment clause.