The Key Coverage Business Partnerships Might Be Missing
There could be a risk flying under the radar in your client portfolio, one you may believe is satisfactorily covered. You can reveal it by answering a seemingly basic question: how are your clients’ businesses structured?
This question matters because standard directors and officers (D&O) liability policies do not broadly address the myriad exposures that today’s executives face. There are many fiduciary capacities within different legal entities, in particular companies that have limited partnerships and/or limited liability companies in their organizational structures. The difference lies in the simple fact that LLCs, corporations and limited partnerships can expose their executives to distinct risks. In all cases, your clients need coverage specifically tailored to address both D&O liability and general partnership liability.
In corporations, executives are largely shielded from personal liability. Directors and officers of a corporation have a duty of loyalty and duty of care, but they generally cannot be held personally financially responsible for a bad decision they make on behalf of the organization. In this case, they are afforded the protection of the business judgment rule. In short, they do not assume personal liability for many of the exposures related to the business.
Both the entity limited partnership and the general partners carry more liability due to the nature of the structure.
A general partner can serve as both a manager and invest alongside their investors. This creates an inherent conflict of interest since they can benefit financially from the partnership they are managing. This leaves them exposed to lawsuits alleging various sorts of misconduct.
Partnership Exposures
This exposure presents a bigger (and more expensive) problem than you might think. Limited partnerships and limited liability companies, which are common in the real estate and energy sectors, can be delicate arrangements, and accusations of various misdeeds can escalate to legal issues in a hurry.
Common allegations may include misrepresentations in order to induce an investor to purchase limited partner interests, misappropriation of the partnership’s assets or funds, as well as misappropriation of partnership opportunities.
In addition, individual general partners and entity general partners and the limited partnership, itself, may be accused of breaching the partnership agreement,
providing excessive compensation to the general partner, fraud, mismanagement or misconduct in the business operations, failing to equitably distribute profits according to the terms of the partnership, or exerting undue influence in causing a partner to amend the partnership agreement against his or her interest.
Historical court cases have included actions against the individual and corporate general partner and the entity limited partnership for breach of fiduciary duties and misrepresentations.
For example, a limited partner plaintiff who were the investors in a limited partnership accused the general partner defendant of purchasing and retaining a piece of land, thus preventing the limited partners from gaining any opportunity or benefit from that purchase or possible sale.
According to the plaintiff – and, ultimately, the judge – this constituted breach of the limited partnership or contract. The plaintiff was awarded upwards of $1.5 million.
Another notable case demonstrates what can happen when there are allegations of breach of the partnership agreement.
The plaintiffs, who were investors in the limited partnership, alleged that the defendant, who was the corporate general partner, failed to pay the correct amount of the preferred return owed to the limited partners as specified in the partnership agreement. The plaintiff also accused the defendant of improperly paying management fees to himself and the corporation he wholly owned. The corporation was also a defendant in this case.
The total judgment against the individual and corporate general partner was $1.6 million. Prior to the trial, the plaintiff settled with the corporation for $2 million.
D&O Alone Does Not Always Protect
Though this may seem like the type of situation where D&O would apply, it does not.
Designed for corporations, D&O coverage protects the board of directors and executives of a corporation in that capacity only against suits brought by stakeholders, such as shareholders, regulators, competitors and vendors. The coverage is designed for allegations that the directors or officers made decisions as managers that led to negative financial outcomes. It does not address if these executives were acting in a different fiduciary capacity like a general partner or partnership manager.
Most standard D&O policies explicitly exclude or restrict coverage for general
and limited partnerships. Some D&O underwriters will attempt to respond to this capacity by providing coverage to individual general partners or by general partnership liability (GPL) endorsement. However, this approach may be imperfect because it does not extend coverage to exposures specific to limited partnership exposures.
General partners and limited partnerships need a defined policy that responds to the risks specific to both corporations and general partners, as well as the limited partnership. Instead of a standard D&O policy, partnerships should seek a blended directors and officers/general partnership liability coverage (D&O/GPL). Though they address the same risks, D&O and GPL are two different types of coverage for two different types of legal structures.
When pursuing a D&O/GPL policy for a client, seek coverage that provides a broad definition of insureds, including directors and officers, individual general partners and corporate general partners. Also seek policies that cover a broader range of entities, from corporations to limited liability companies and scheduled limited partnerships. A comprehensive policy will also provide automatic coverage for newly formed or acquired partnerships, as well as subsidiaries of the insured organization.
There’s one promise I can make to agents and brokers: you have these risks in your client portfolio. These are difficult exposures requiring the proper coverage with adequate limits.
When advising a new client, be cautious about steering them towards a standalone D&O policy. Their business structure may necessitate an executive liability package that includes D&O/GPL coverage. And do not forget to review existing clients’ organizational structures next time their D&O policy comes up for renewal. You may find they are taking unnecessary risks in their business.