Directors & Officers Liability Insurance (D&O Insurance) provides protection for the personal liability of directors and officers of a company while they are performing their roles as directors and officers. It is purchased by the corporation for the benefit of their directors and officers to protect them if they are accused of making management errors. It is an important tool that assists your company in attracting and retaining talented officers and directors, as many executives will not work for a company that puts their personal assets at risk.
This insurance is a form of liability insurance that is payable either to the directors and officers of a company or to the company itself as a reimbursement for covering the losses of its directors and officers. Directors & Officers Insurance may also advance the payment of legal defense costs. It is meant to cover losses suffered by officers and directors as a result of legal action brought against them for alleged wrongdoing in their roles as officers and directors.
Many management teams mistakenly believe that the company’s general liability insurance will cover their liability. However, commercial general liability insurance only covers the company itself. It does not provide protection against lawsuits that name them personally and also does not cover management mistakes. Lawsuits can be very expensive to defend even when they are without merit, so having D&O Insurance can help protect the personal assets of corporate directors and officers.
Coverage from D&O Insurance can also cover defense costs from criminal and regulatory investigations or trials. Often, a government or regulatory agency may bring both criminal and civil prosecutions against an officer or director. Although D&O Insurance does not cover intentional criminal acts, it will pay for the criminal defense of a covered person until that person has been found guilty.
D&O Insurance is applicable to for-profit, nonprofit and privately held businesses.
Our company doesn’t have outside shareholders. Do we need D&O Insurance?
A common misperception is that D&O Insurance is only applicable for companies who have outside shareholders. However, the most common type of lawsuit against directors and officers comes from dissatisfied employees rather than other shareholders.
Plaintiffs in D&O claims can include employees, customers, vendors, competitors, regulators, creditors and others. Any of these third-parties could target your board members or management team with lawsuits, even if your company is privately held.
Since even frivolous lawsuits can be expensive to defend and resolve, having D&O Insurance can provide protection for the personal assets of your directors and officers.
Indemnification
Most company articles of incorporation or articles of organization provide for the indemnification of officers and directors. Indemnification is an agreement to compensate officers or directors for any financial losses or damages they personally suffer as a result of actions they took while acting in their role of officer or director.
Most indemnification agreements are unlimited up to the maximum amount permitted by law, which means the company promises to cover all of an officer or director’s costs and losses. However, practically speaking, this indemnification is limited by the financial resources of the company.
Some states also prohibit the indemnification of officers and directors.
Directors & Officers Insurance is purchased in addition to corporate indemnification of directors and officers. Many officers and directors want a company to provide both indemnification and D&O Insurance.
Types of Claims
Directors & Officers Insurance protects against a wide variety of claim types. This insurance will also pay to defend against frivolous claims without merit.
Besides shareholder lawsuits, Directors & Officers Insurance will pay to defend against lawsuits from employees, customers, competitors, vendors, regulators, creditors, and others.
The most frequent claims for Directors & Officers Insurance are related to employment issues. Employees may be dissatisfied with the way they have been treated by the company and decide to sue the company and its officers or directors.
The claims that tend to be most expensive are shareholder lawsuits and regulatory actions. However, these types of claims occur much less frequently than other types of claims.
Here is a list of possible claims that Directors & Officers Insurance covers:
- Shareholder claims:
- Damage to the corporation in breach of their legal duty.
- Breach of fiduciary duty resulting in financial losses or bankruptcy.
- Failure to follow the organization’s bylaws or lack of corporate governance.
- Misuse of company funds or mixing personal and business assets.
- Innocent errors in judgment by executives may cause claims.
- Failure to disclose conflicts of interest.
- Customer/Vendor claims:
- Misrepresentation of company assets.
- Fraud.
- Breach of contract.
- Employee claims:
- Failure to comply with workplace laws.
- Discrimination.
- Wrongful termination.
- Invasion of privacy.
- Infliction of emotional distress.
- Sexual harassment.
- Competitor claims:
- Personal injury: defamation, libel, and slander.
- Publisher’s liability: plagiarism and copyright infringement.
- Theft of intellectual property or trade secrets.
- Poaching of competitor’s customers or employees.
- Regulator claims:
- Failure to comply with regulations.
Coverages of a Directors & Officers Insurance Policy
There is no standard form for Directors & Officers Insurance, so each insurer’s policy may be different. The most common form of a D&O Policy has 3 coverages, sides A, B, and C.
Side A provides coverage for non-indemnified directors and officers. It covers individual directors and officers when they are not indemnified by the corporation as a result of state law, or if the company does not have the financial resources to indemnify them.
Side B provides coverage for the corporation. It reimburses the corporation when it indemnifies the officers and directors.
Side C also provides coverage for the corporation. For public companies, it protects the corporation against securities claims brought against the company. For private companies, it covers claims that name both the company and its officers and directors that are not covered by general liability insurance.
Exclusions
There are a few important exclusions to Directors & Officers Insurance.
Intentional illegal acts are excluded from coverage under D&O policies. Criminal fraud is also not covered. Although illegal acts are excluded, the insurance company will pay for the cost of criminal defense for officers and directors up until the accused is found guilty.
If the director or officer is found not guilty, the D&O policy will cover the costs of criminal defense. If the accused is found guilty, however, the insurance company reserves to right to recoup the expenses they have incurred in defending the officer or director.
It is also important to ensure your D&O policy includes severability, which will allow coverage to continue for the remainder of the directors and officers if one of the directors or officers is found to have committed a crime. Severability will allow the innocent directors and officers to continue to be insured.
Insured vs insured lawsuits are those between two parties who are both insured by the D&O Insurance. For example, one director may sue the rest of the directors of the company. This clause exists in order to prevent collusion, where two parties collude in order to collect from the insurance company. It also is meant to keep the insurance company out of company infighting, which can be difficult for an insurer to resolve.
Shrinking Limits of Insurance
Directors & Officers Insurance features “shrinking limits” of insurance, which means that legal defense costs are included within the limits of insurance. This is in contrast to commercial general liability, where legal defense costs are not counted against the limits of insurance.
The reason for the “shrinking limits” is that more than half of D&O claims close out with zero indemnity, which means the legal costs account for a significant portion of the claims.
Claims-made Policies
Directors & Officers Insurance policies are written on a claims-made basis. These policies will only cover claims if the claims are submitted while the policy is active. This differs from other liability insurance policies which are typically occurrence policies, such as commercial general liability insurance. If your claims-made policy is not active, you do not have any coverage for past actions even if the actions causing the claim were committed while the policy was active.
For example, your company has a claims-made Directors & Officers insurance policy that expires in December 2016, and the policy is not renewed or replaced. The directors of the company approve a decision to purchase capital equipment in November 2016. In January 2017, the company discovers the purchase was a poor decision and leads to financial losses. Shareholders sue the directors for neglecting their fiduciary duty. Since the coverage is no longer active, the directors do not have coverage for the lawsuit, even though the decision was made while the insurance was active.
Most Directors & Officers Insurance has an unlimited retroactive period, which means it covers claims for wrongful acts that took place before the policy began.
Representations and Rescission
D&O Insurance is issued based on statements given by your company. These statements are considered representations, which means that you promise the statements are true. If, at the time of a claim any of the representations are found to be false, it can limit your coverage, or void the insurance contract altogether, which is called rescission. It is important to ensure your representations are correct when applying for D&O Insurance.
Some insurers offer non-rescindable policies, usually for a higher premium.
Pricing
Factors affecting the pricing of D&O insurance premiums include:
- Company size
- Industry
- Claims history
- Mergers & acquisitions history
- Professional background of directors and officers
- Company profits
- Company debts