The following is from
Ask The VC, where Brad Feld and Jason Mendelson of
Foundry Group answer questions related to venture capital investment and startups:
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.
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