Like many small businesses, your firm may be a private corporation owned by family members or close associates. Because your company isn't listed on a public stock exchange, you might assume your firm's executives will never be sued for wrongful acts so they don't need directors and officers insurance. Unfortunately, your assumption may be wrong.
Lawsuits Against Private Company Directors
In 2016, the insurer Chubb surveyed 600 private companies to assess their concern about various corporate risks, including claims against directors and officers. The survey showed that only 43 percent of the companies had purchased directors and officers (D&O) insurance . About a third of the companies that hadn't bought the coverage thought they didn't need it because they were privately owned or family-operated.
While many of the survey respondents thought D&O insurance was unnecessary, 26 percent of the companies had incurred a D&O loss within the previous three years. The average loss was substantial ($399, 394). The claims originated from various sources, including customers, competitors, vendors, regulators, and shareholders.
Buying D&O Insurance
Private companies may purchase D&O coverage from standard insurers like The Hartford or Nationwide, or specialty insurers like the Philadelphia Insurance Company. D&O coverage may be obtained alone or as part of a management liability policy. This term means a package policy designed to protect the organization and its directors, officers, and managers from claims alleging wrongful acts. Besides D&O, a management liability package may include employment practices liability, cyber liability, kidnap and ransom, and various other coverages.
When shopping for D&O insurance, look for a policy that's designed for private companies. Private company D&O policies contain fewer exclusions than policies intended for public companies.
Features of Private D&O Coverage
While private company D&O policies vary, they have many characteristics in common. For instance, virtually all are claims-made, meaning they limit coverage to claims made during the policy period. Some other common features are outlined below.
A typical private company D&O policy includes three insuring agreements. The first provides directors and officers (Side A) coverage. It pays claims against individual directors or officers who have not been indemnified by the corporation.
Directors and officers are personally liable for acts they commit while performing their duties on behalf of the corporation. Thus, the firm's bylaws typically state that the company will indemnify its directors and officers for the costs (damages and defense expenses) that arise from such suits. However, a firm may unwilling or unable to provide indemnification in some circumstances, such as the firm's bankruptcy. In these situations, Side A coverage will apply.
The second insuring agreement affords indemnification (Side B) coverage. It reimburses the corporation for damages and defense expenses the company has paid to (or on behalf of) directors or officers as indemnification. The third insuring agreement provides corporate liability (also called entity or Side C) Coverage. It pays claims brought directly against the corporation.
Defense and Settlement
Many D&O policies designed for private companies state that the insurer has a duty to defend. This means the insurer will choose the attorney and control the insured's defense. If a policy doesn't include a duty to defend, then the insured generally has the right to select the attorney (often subject to the insurer's approval). In this case, the insurer will indemnify the insured for the costs of defending the claim.
Many policies contain a "hammer" clause that applies if the insured rejects a settlement offer recommended by the insurer and accepted by the claimant. This clause typically requires the insured to pay a portion of the difference between the actual settlement amount and the amount the insurer initially offered.
While some D&O policies cover criminal proceedings filed against a director or officer, coverage is usually limited to defense costs unless a court absolves the individual of the criminal charges.
While exclusions vary, most private company D&O policies exclude the following types of claims:
- for bodily injury or property damage
- by one insured against another. An exception applies to shareholder derivative suits, which are suits filed by shareholders against a director or office on the company's behalf. The suit typically alleges the director or officer has committed acts that have harmed the company.
- for fraud, dishonest acts or profits obtained illegally if a court has determined an insured has committed one of these acts
- based on circumstances that were the subject of lawsuits filed prior to the policy inception date or that were pending on that date
- reported under previous D&O policies
- arising from the public offer of securities
- alleging pollution
- alleging violations of the Employee Retirement Income Security Act of 1974
Most D&O policies define the terms listed below. Depending on the wording used, these definitions may broaden or restrict coverage.
- Claim. Besides lawsuits (civil proceedings), this term may include administrative or regulatory proceedings, criminal proceedings, alternative dispute resolution proceedings, subpoenas or investigative demands, and demands for monetary or non-monetary relief. Non-monetary relief includes specific performance (an order to perform some action) or an injunction (an order to stop doing something).
- Insured Persons. Typically includes natural persons (human beings rather than non-human legal entities) that are current, past or future directors and officers if duly elected or appointed. May also include managers and employees
- Loss. Generally includes damages, settlements and defense costs. May also include punitive damages where insurance of such damages is permitted by law
- Wrongful Act. Generally includes any actual or alleged act, error, omission, misstatement or breach of duty