Private equity funds, and individuals affiliated with fund sponsors, are increasingly being named as defendants in lawsuits involving their portfolio companies. This litigation risk arises most frequently where a fund controls one or more board seats on the portfolio company, or where an individual affiliated with the fund sponsor serves as a senior executive at the portfolio company.
When a fund sponsor (or an individual affiliated with a fund sponsor) is named as a defendant in a lawsuit involving a portfolio company, the initial assessment of the claims, risks, insurance coverage, and indemnification rights is critical. Some of the key questions for that early assessment are:
- What are the board designee’s indemnity rights? Typically, the board designee has indemnity rights at multiple levels, including the portfolio company level, the fund level, and potentially the management company/sponsor level. The interplay between the rights at different levels, and the priority of the indemnitors’ obligations, requires careful assessment. Also, it is important to understand that an indemnity right is subject to “credit risk,” as the indemnity is only as strong as the balance sheet of the indemnitor.