How the proliferation of bankruptcy has impacted the Directors and Officers market place and how Venture Firms can protect their Outside Directors?

How the proliferation of bankruptcy has impacted the Directors and Officers market

place and how Venture Firms can protect their Outside Directors?

Venture Capital, one of the main drivers of private investment in this country, has seen radical changes to the business landscape in the past three years. The economic downturn has forced many of their portfolio investments to file for bankruptcy costing the firms hundreds of millions of dollars, not to mention their limited partners and the founders of their invested entities. What happens when a company is shuttered? Who is responsible for the wind down? What happens to the founders and employees? What about the Venture firm, are they held accountable? The ripple effect of a portfolio company's bankruptcy can have a myriad of implications for the various stakeholders in the game and raises important questions about the insurance structure in place to help save and protect the Venture firms' assets as well as the assets of the portfolio company's Directors and Officers.

After a company fails, the founder and employees are immediately off to find their next job leaving only the Directors to wind down the company. Once in Bankruptcy, the courts will appoint a Trustee to oversee the liquidation; this is where the fun begins. The Trustees job is to find as much money to give back to creditors. Often since the company has no money, the look at the decision made by the directors and officers to see if their decision were prudent during the company's lifetime. Often the Trustees will bring suit against the directors and officers for decisions made that were not in the best interest of the company. Since the company went bust, this is often not a difficult task.

The portfolio company's Directors and Officers liability policy is the first line of defense, but in most bankruptcies the insurance winds up not getting paid and it cancels. Since Directors and Officers policies are Claims-Made Policies, the policy must be in force at the time of claim. If the Directors of the company are diligent they may see bankruptcy is the likely outcome and inform the insurer to exercise the extended reporting provisions with the policy (tail coverage) which allows claims to be brought for a specified period beyond the closure of the company. This is great in theory, but often does not happen because the company has no money to pay the premium and the directors are left to defend themselves. If you are an independent director it would be prudent to buy your own Individual Director Liability (IDL) policy, particularly if you sit on many boards. If you are the appointed board member for the Venture firm you may have one more line of defense, if the firm has their own Management Liability policy. This combination Directors and Officers/Professional Liability Policy provides protection to the appointed board members of the firm. The Outside Director Liability section of the Management Liability policy extends the policy limits to the appointed directors in excess over any available indemnification or collectible insurance at the portfolio company level. Keep in mind this is only available for the Venture Firm's directors.

Claims against directors and officers as a result of bankruptcy have become prolific in the past few years. As a Director, ask questions about your protection. Venture firms make sure your policy conforms to the new regulations and industry climate. If a bankruptcy hits one of your portfolio companies, make sure there is enough money to pay for the Extended Reporting Period. As a last resort, the directors can pay for the extended reporting period premium themselves. This may be the best pre-paid legal fees you will ever buy.

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