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SEC Adopts Rule Change to Address Funds’ Auditor Independence Problem

In a June 18, 2019 release (the “Release”), the SEC adopted amendments to the “Loan Rule” (as defined below), a part of the SEC’s auditor independence rule, Rule 2-01 of Regulation S-X. The amendments, which were proposed in 2018, should virtually eliminate the problems that led to the SEC staff’s 2016 no-action letter regarding the application of the Loan Rule to an investment company complex.

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Delaware Chancery Court Offers a Partial Solution to Recent Decisions that Adversely Affect Private Equity Fund Indemnification


Time to Read: 2 minutes Practices: Private Investment Funds, Corporate & Securities Litigation, Private Equity, Securities & Public Companies

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A recent Delaware decision provides guidance to private equity organizations seeking to avoid co-indemnification obligations with the sponsor's portfolio company for an investment professional who is serving as a director or officer of the portfolio company. 

In Sodona v. American Stock Exchange LLC, the Chancery Court provided a partial roadmap to address an earlier Delaware decision that disrupted settled expectations concerning the respective obligations of a private equity fund and its portfolio company to pay advancement and indemnification to, or on behalf of, a principal of the private equity fund serving as a director or officer of the portfolio company. This decision offers some relief from the Chancery Court's decision in Levy v. HLI Operating Co., which raised the very real prospect that, in the absence of appropriate contractual provisions at the private equity organization and/or portfolio company levels, a portfolio company could successfully take the position that the private equity fund or its affiliates is a "co-indemnitor" (along with the portfolio company) and, as such, is obligated to indemnify each of the private equity fund's board designees at the portfolio company on a "co-equal," or pro rata, basis with the portfolio company.

In particular, in Sodona, the Chancery Court enforced a contractual prioritization term providing that a parent corporation's obligations to indemnify directors serving at a subsidiary, at the request of the parent, would only take effect if the subsidiary were financially or legally unable to make an advancement or indemnification payment.  Otherwise, the subsidiary is obligated to indemnify on a primary basis. The Court held that this provision was sufficient to permit the parent to avoid co-indemnitor status with its subsidiary. 

Takeaways from Levy and Sodona
Certain takeaways from the recent Delaware decisions include the following:

  • Absent clear contractual provisions, the Delaware courts will not presume that a private equity organization's obligation to indemnify its director designees is secondary to the portfolio company's obligation to indemnify the directors.
      
  • Absent such contractual clarity, a private equity organization is at risk of being required to pay indemnification to its director designees despite a portfolio company's indemnification obligation to the designees.
      
  • There are several reasonably efficient alternative solutions for the problem raised by Levy v. HLI. Op. Co., which, as a practical matter, do not require extensive review and amendment of each portfolio company-level or fund-level agreement.
      
  • To effectively address the issue raised by these cases, it is important to carefully consider a private equity organization's particular circumstances and the options available to the firm.

Private equity funds and other companies should take notice of the Sodona decision. The articles "Director and Officer Liability: Delaware Reinforces the Limits on Indemnification Claims" and "Advancement and Indemnification Update: Sodona v. American Stock Exchange" by Ropes & Gray partners Randall Bodner and Peter Welsh further describe each of the above cases and potential solutions to the issues that can arise from this developing area of the law.

Contact Information
If you would like to learn more about these recent Delaware decisions, please contact your legal advisor at Ropes & Gray or a member of our Private Investment Funds team.

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