When VC Partners Sue Each Other: New Venture Capital Claims on the Rise

Premiums have been rising slightly in the venture capital insurance market over past two years. The reason is straight forward: claims activity has been increasing.  Some of the claims are the result of increasing employment litigation of the kind that has affected all companies.  But there is another wave of lawsuits emerging in the venture world.

Litigation arising out of disagreements between senior and junior venture investing partners is an emerging trend.  These claims are becoming more commonplace due to the generational shift in the VC industry; veteran partners at VC firms are retiring from the business, and new blood is coming in to take over. In many of these suits, a junior investing partner or partners allege the senior partners have misrepresented the ownership stake that the junior partners have in the general partnership, and are defrauding them of the appropriate amount of carried interest.  This new wave of suits is leading to changes in professional liability coverage for venture firms.

Mitigating Risk for Venture Capital Firms

All Venture Capital professional liability policies contain an “insured vs. insured” exclusion.  This is a concept that insurers borrowed from directors & officers liability policies. The insurance carriers’ intention is to prevent collusion by insiders in the form of suing each other in order to reap a windfall in insurance policy proceeds, perhaps as funding mechanism to make up for a shortfall in earnings or investment returns.  In a “standard” Venture Capital professional liability policy, any suit by one investing partner against another would be excluded.  Over the past few years, as the venture capital insurance market became more competitive, insurers were willing to narrow the scope of the insured vs. insured exclusion.  Although no insurer was willing to remove the insured vs. insured exclusion entirely, many of insurers narrowed the exclusion by recasting it as an organization vs. insured exclusion.  With an organization vs. insured exclusion, only suits by or on behalf the firm or fund are excluded – suits by one partner against another would be covered by the insurance policy.

There is little consistency in the market around this policy language. If you find yourself responsible for navigating VC management liability on your own, here are a few tips to help you sort through the options:

1. Watch Your Language

You may want the preferred organization vs. insured exclusion which is only offered by a few insurers.  Be aware thatmany insurers are reverting back to the old insured vs. insured exclusion - this is in response to partner infighting claims.  Furthermore, each insurance company approaches the insured vs. insured/ organization vs. insured exclusion differently.  The particular wording should be customized to fit the unique risk profile of your firm.

2. Choose the Right Broker

Finding an insurance broker who can help you identify policies that are right for you and possesses the technical expertise to sort through the coverage language is a challenge. Here are a couple tips:

• It’s smart to work with an insurance broker who understands venture policies inside and out and places a lot of these policies.   The volume of placements drives experience, and helps your broker obtain the best possible terms and conditions for you.  Keep in mind that few brokerages truly specialize in this line of insurance.   You will want to ask how many Venture firms your broker represents. You can also ask for references.
• Make sure the broker also understands the venture capital industry.  It’s an easy trick for insurance carriers to avoid coverage by issuing language that isn’t tailored to exactly fit what a firm and its partners need. Each VC firm has special needs and circumstances that aren’t usually represented in a generic, off-the-shelf policy.  Also, a firm’s ability to obtain generic, industry-related endorsements does not make them a specialist.
• Lastly, if it sounds too good to be true, it probably is. Catch phrases like “exclusive program” should be treated with suspicion.  When trying to protect a your reputation and your personal net worth, find a partner you can trust that has a proven track record in the industry.