What is a Key Man Clause?
Key Man Clause is a clause used in a contract which is used for one or more “key man” (main person of the contract, usually fund manager or key partner) to do or not to do a specified action and may result into termination of the contract is breached and is mostly seen in limited partnership companies, venture capital organizations and mutual fund companies.
It is an important clause for an investment firm that prohibits them from making investments when the key executives are not available for fail to devote time to the investments. It says if certain numbers of executives are absent, the investment firm won’t be able to make any new investments until these key executives are replaced first.
There can be many reasons for which the executives aren’t able to perform their tasks quite well. Since managing investments is a huge task, the key executives (who are in charge) invest a large chunk of time. When they’re unable to do that, according to the key man clause they should be replaced.
Now, let’s look at the possible causes for which the key executives aren’t able to provide enough time in managing investments.
When will Key Man Clause apply?
Among these causes, some are unavoidable causes and some are avoidable causes.
- Death: If the key person dies, there’s nothing one can do about it. In that case, the key man clause will apply.
- Suffers from a long-term disability: This is also one of the unavoidable causes. What would the key executive do if she suffers from a disability or disease?
- The key executive has quit the job: If the executive has got a new job with better prospects, there’s nothing an investment firm can do about it.
- The executive is fired: If the key executive is fired for any reason, a key man clause will apply.
- Does other tasks more efficiently: If the key executive does another task more efficiently than managing the investments, then it’s high time that she should be removed and replaced by someone more responsible.
- The executive is convicted of a crime: This is a serious threat to an organization. What if the clients get to know that the investment manager is a criminal? What would the investment firm do? The Keyman clause will apply here as well.
Why it is Important?
- A huge amount of money is at stake: To an investment firm, it’s a huge responsibility to manage investments. And they do not only manage the investments of one or two clients. The number is huge, often more than a million or a billion dollars. In that case, if the executives who are managing the investments aren’t sincere (or have unavoidable issues); then the investment firm must replace them.
- The reputation of the investment firm: If the investment firm decides not to replace them, then the efficiency of the investment firm will be questioned. And this is by no means a good thing for that particular investment firm’s future prospects.
- Investments firm need to produce key man clause: Now many start-ups, foundations, investors are asking for key man clause as their guarantee before employing an investment firm. These start-ups, foundations, investors want to make sure that the investment firm would take the utmost care of their investments and wouldn’t allow any executive to handle the investment until the person is the most qualified and eligible. Nowadays, the key man clause has become a mandatory clause that every investment firm must think about.
How to Implement a Key Man Clause?
If you’re running an investment firm (or an investor and wants to understand how key man clause works), here’re three things you should keep in mind –
Add the “key man clause” to everyone who comes under a contract with the firm
First of all, you need to look at the contract of those who’re making key decisions for clients’ investments. And then you need to add the key man clause in their contract. Later, you need to create a mandate that everyone who joins the investment firm should have the key man clause inserted into their contracts.
If you’re a small firm and you really can’t take the risk of replacing your limited resources, then buying key man insurance is the right thing to do. If you’re a big firm and have ample resources and budget to replace your key decision-makers, you don’t need to buy key man insurance.
Think about the worst-case scenario
Adding the key man clause to the contract of your key decision-makers and buying key man insurance is a great starting point. But you also need to prepare for worst-case scenarios. If you can write down an emergency plan and adhere to it, you would be prepared for any worst-case.
In this guide to Key Man Clause, we discuss how does it work, when does key man clause apply, why it is important and also how to implement key man clause. You may also look the following articles to learn more –