- Flex-workspace firm Knotel sourced surety bonds from startup Rhino that cover the hefty security deposits due for two of its office leases if Knotel abandons the commitments.
- But Rhino did not disclose to reinsurer Knight Re that its cofounder and CEO is the younger brother of Amol Sarva, the CEO of Knotel, raising a potential conflict of interest.
- In recent months, Knotel has let millions of dollars in bills to vendors and landlords go unpaid. Its CEO said it will walk away from leases, which could leave Knight Re on the hook for substantial payouts.
- Click here for more BI Prime stories.
Flex-office firm Knotel and the insurance startup Rhino failed to disclose a family tie between the two companies when the pair struck a deal to place an insurance firm on the hook financially if Knotel defaults on office leases it has signed, according to the insurer involved in the transaction.
Rhino issued what’s known as surety bonds for two office leases signed by Knotel, a type of insurance product that will cover the cost of the hefty security deposits due for the spaces if Knotel walks away from its obligations to continue renting them – an event that could soon come to pass. Knotel’s chief executive Amol Sarva recently warned the struggling workspace company will shed 20% of its portfolio.
Knight Re, a Cayman Islands-based reinsurance company, said it didn’t know when it took on the role of backstopping the coverage for the security deposits that Knotel’s Sarva is the older brother of Rhino CEO Paraag Sarva.
“We were not initially aware of the familial relationship between Rhino and Knotel,” said John Rygh, vice president and general counsel for Knight Insurance Group, the Los Angeles-based parent company of Knight Re. “When we learned of the connection we immediately informed Rhino no similar bonds could be issued due to the appearance of impropriety.”
Rygh said he did not believe the omission amounted to purposeful wrongdoing by any of the involved parties, including Knotel and Rhino.
“We continue to monitor and are not aware of any actual improprieties,” Rygh said. “There have [been] no claims on the two Knotel bonds.”
Knight Re followed up with a request that Business Insider retract its statements concerning Rhino, citing confidentiality concerns. The company did not specify any inaccuracies in its original statement and executives at the company did not respond to requests for additional comment.
Knotel, which has amassed a 2.5 million square foot portfolio in the city, has slashed its staff amid the coronavirus crisis in recent weeks and missed revenue targets last year. In recent months, it has let millions of dollars in bills to vendors and landlords go unpaid. Its CEO Sarva recently said it will walk away from leases, which could leave Knight Re on the hook for substantial payouts if Knotel severs the two deals that utilized the surety bonds backed by the reinsurer.
A default could prompt questions whether there was a conflict of interest for Rhino in issuing the bonds to Knotel in the first place.
Rhino sources policies on behalf of insurance partners, who rely on the startup to help manage risk and determine market pricing for policies they place through Rhino. Those responsibilities could theoretically have been biased by the undisclosed relationship, insurance experts said.
“Insurers give agents the power of the pen, meaning they can bind the insurance company to a particular policy,” said Michael Menapace, a Hartford-based insurance attorney with the firm Wiggin and Dana LLP. “The insurance companies are trusting their agents to do the due diligence and dispassionate analysis to determine whether this is a good risk and at what price. As an insurer, I would want to know if there was a relationship there.”
The situation arose in an emerging niche of the insurance business where industry practices are still taking shape.
Tenants across the city’s commercial office market have long been required to pledge security deposits when they take office space in order to compensate landlords, who often grant tenants financial incentives to commit, in the event they abandon the lease midstream before the property owner can be recouped.
The deposits require tenants to tie up sums of cash that can run into the millions of dollars for substantial lease commitments. Those payments have become especially burdensome for flexible workspace firms such at Knotel, which have signed dozens of leases in rapid succession in recent years to gain scale as the industry boomed, locking away tens of millions of dollars of security in the process.
Beginning last year, Rhino began offering a type of insurance known as surety bonds to commercial tenants as an alternative to the costly deposits. The bonds place an insurer on the hook if a tenant breaks from a lease commitment in return for a premium paid on the policy by the tenant that usually amounts to 5-10% of the size of the security deposit that is insured, a Rhino executive told Business Insider. Knight Re played a role in the Knotel deals done by Rhino by financially protecting the primary insurer in case there is a payout.
A Knotel spokeswoman said that Amol Sarva was not involved in its efforts to source surety bonds.
“Amol has not been involved in any discussions on choosing surety bond partners,” the spokeswoman Ivy Chiou said. “Knotel works with many partners, all on an arm’s length basis. Any conflicts are reviewed by the board, with conflicted persons removed from the process.”
A Rhino spokesman declined to confirm whether the company has worked with Knotel and said any underwriting of surety bond policies was done objectively and without conflict.
“Rhino engages in a comprehensive, objective underwriting process for each of its commercial deals,” Jordan Stein, a Rhino executive, said in a statement. “There is no preferential treatment given to any particular partner, and we do not disclose the identity of partners or the terms of specific deals.”
Rhino has been an advocate for security deposit insurance
Rhino has raised about $28 million in funding from investors, including Starwood Capital and the venture firm Lakestar, according to the startup investment database PitchBook. It has become a leading player in the growing business of selling security deposit insurance with its focus, so far, on originating policies for residential renters. That business has taken on a higher profile as executives in the insurance industry, including Rhino CEO Paraag Sarva, have lobbied for laws that allow renters to replace or liquidate their security to access that cash amid the Covid-19 economic crisis.
Rhino has won support for its products from New York elected officials, as well as local governments in other cities, according to a recent press release. The security deposit insurance industry received another boost when Governor Andrew Cuomo recently ordered that residential tenants be allowed to liquidate their security to pay rent, a mandate that deposit insurance companies believe will lead to a major uptick in business.
As much as $45 billion nationally and $8 billion in New York City is tied up in residential deposits that often sit idle, according to estimates.
Last year, the company sought to expand its business into the commercial real-estate market. The executive at Rhino, Michael Dubin, said the company has so far originated about $10 million of surety bonds tied to the city’s commercial leasing market. He imagined a day when the product will become commonplace in office leasing, relieving tenants from the burden of having to tie up their cash to take office space.
Other coworking companies have turned to surety bonds
Knotel is not alone in seeking a workaround to placing deposits by using insurance products. According to several sources and published reports, its rival WeWork sourced surety bonds from the Switzerland-based insurance company Chubb in recent years to replace tens of millions of dollars of deposits in its multi-million square foot portfolio.
Nor is Rhino the only firm that sees room for growth in the business of offering surety bonds to the commercial leasing market, especially as tenants become eager to tap that cash to help survive the crisis.
“We have done dozens of deals in New York City and across the country in large metro areas,” said Kendall Miller, an executive at the security deposit insurance provider, The Guarantors. “Anyone can benefit right now from the increased liquidity this provides.”
Have a tip? Contact Daniel Geiger at dgeiger@businessinsider.com or via encrypted messaging app Signal at +1 (646) 352-2884, or Twitter DM at @dangeiger79. You can also contact Business Insider securely via SecureDrop.
Leave a Reply
Leave a Reply
This site uses Akismet to reduce spam. Learn how your comment data is processed.
