In the following guest post, Sarah Abrams, Head of Professional Liability Claims Bowhead Specialty Underwriters, Inc., and Steven Kane, Head of Financial Institutions Underwriting, Bowhead Specialty Underwriters, Inc., take a look at insurance coverage issues that could arise in connection with the separation of a principal or partner from a private equity firm. I would like to thank the authors for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors from topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.

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Private Equity General Partnership separation can bring a host potential insurance exposure to the firm’s Professional Liability, Employment Practices, and Directors and Officer policies. When a for-cause separation of a General Partner occurs, is insurance coverage available for a dispute surrounding the ouster and for potentially profitable carried interest?

Carried interest (carry), typically 20% of the amount of funds realized in excess of original committed capital, represents share of a fund’s net profits allocated to General Partners.[i] Carry is incentive compensation provided to align individual General Partners’ interests with the fund’s capital-providing investors and is kept on top of management fees. Carry shares are often not monetized until the end of a fund’s life, remaining illiquid in the interim.[ii]

There are many types of carried interest (long-term gains, dividends, short-term gains, or interest) and no globally accepted standards for arriving at a private equity investment valuation. [iii] Thus, determining the amount of carry owed to an exiting General Partner requires sophisticated accounting and, more often than not, attorneys[iv].

Should a General Partner be asked to leave for cause, including violation of Federal or state securities laws, criminal acts, intentional misconduct, and dereliction of duty or other material breaches of obligations, the anticipated claim against the Private Equity Firm and General Partner may not trigger the Firm’s Director and Officer liability policy or indemnification.[v]

The ousted General Partner often turns around to demand their carry shares from the Firm in the form of an attorney letter or draft complaint, which may fall within the Firm’s Director and Officer Policy definition of a “Securities Claim.” The insurance coverage waters are further muddied when the demand includes allegations that may trigger employment practices coverage.

Read the full article on The D&O Diary.