Dec 9 2008 by Jason

Why Is My Venture Capitalist Wasting My Money By Changing My Indemnification Agreements?

I’ve gotten several emails recently from folks complaining that their VCs are wasting their legal spend on changing indemnification agreements.  What is going on and why is this important?

Mike Sullivan at Howard Rice has the best plain English explanation that I’ve seen:

Let’s say you’re a VC and you sit on the board of a portfolio company. Something goes wrong at the company; and the plaintiffs sue everyone in sight, including you. You don’t welcome the idea of paying litigation costs out of pocket, but luckily you have an indemnity agreement from the portfolio company – saying that the company will cover litigation costs and liabilities. You also are indemnified by your VC fund, but until recently most people thought that was just a “backup” – in case the portfolio company was insolvent.

But that was before the recent Levy v. HLI Operating Company case. There, a Delaware court surprised most experts by holding that where the individual board member had indemnity rights both from the portfolio company and his fund, the fund and the portfolio company had to share claims for any indemnity claims required to be paid.  [This clearly will lead to a financial and process nightmare dealing with different insurance carries and attorneys. – Ed.]

The result? VCs are changing their indemnity agreement forms. The NVCA form of indemnity agreement has been changed to make it clear that the portfolio company indemnification is the board member’s primary source of protection, and the VC fund will have to pay only if the portfolio company is unable to do so. Since most people assumed that was true prior to the Levy case, our experience is that most companies aren’t fighting this change.