Directors and Officers Coverage for Private Companies
Like many small businesses, your firm may be a private corporation with only a few shareholders. Because your company isn't listed on a public stock exchange, you may assume that it has no need for directors and officers liability coverage. Unfortunately, this assumption would be wrong. Directors and officers of private companies are subject to lawsuits from a wide variety of sources. These include competitors, vendors, employees, regulators, and customers.
Small business owners may purchase directors and officers (D&O) liability coverage by itself or as part of a management liability policy. The latter is a type of package policy that includes D&O, employment practices liability and fiduciary liability (a type of errors and omissions coverage for managers of employee benefit funds).
D&O policies are not uniform and vary from one to another. Many insurers have developed multiple policy forms. Each policy is generally tailored to a specific type of organization such as private, public, or non-profit companies. Because most small businesses are not public companies, this article focuses on D&O policies designed for private companies.
D&O policies apply on a claims-made basis, meaning they cover claims made during the policy period. Policies differ in their claim reporting requirements. Some limit coverage to claims reported during the policy period. Others include claims reported during a specified time period (such as 60 days) after the policy expires. Some policies provide the option to purchase an extended reporting period.
Directors and officers are personally liable for acts they commit while performing their duties on behalf of the corporation. Thus, a company's bylaws typically state that the firm will indemnify directors and officers for the costs (damages and defense expenses) of lawsuits. State law may prohibit a company from providing indemnification for certain types of claims.
A typical private company D&O policy includes the following three insuring agreements.
- Directors and Officers Liability: Often called Side A coverage, this insurance applies when a director or officer has been sued, and he or she has not been indemnified by the corporation.
- Indemnification This coverage reimburses the corporation for damages and defense expenses it has paid to (or on behalf of) directors or officers as indemnification. This coverage is referred to as Side B coverage.
- Corporate Liability Covers damages and defense expenses that result from claims brought directly against the corporation. Often called Side C or Entity Coverage.
The coverage provided by a D&O policy may be broad or narrow depending on the manner in which certain key terms are defined.
- Claim Besides lawsuits (civil proceedings), this term may include administrative or regulatory proceedings (by government entities), criminal proceedings, alternative dispute resolution proceedings (such as an arbitration proceeding), 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). Some policies include subpoenas served as part of a regulatory investigation.
- 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.
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.
Defense and Settlement
Many policies designed for private companies state that the insurer has a duty to defend. In this case, the insurer selects the attorney and controls the insured's defense.
If a policy does not include a duty to defend, then the insured generally has the right to select the attorney (although the insured's selection may be 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.
Exclusions vary from one policy to another. However, virtually all D&O policies exclude claims:
- for bodily injury or property damage
- by one insured against another
- for fraud, dishonest acts or profits obtained illegally. This exclusion may not apply until a court has determined that a person has indeed committed one of these acts.
- based on circumstances that were the subject of lawsuits filed prior to (on pending on) the policy inception date
- reported under previous D&O policies
- alleging pollution
- alleging violations of the Employee Retirement Income Security Act of 1974
In most policies, the "insured versus insured" exclusion contains an exception for shareholder derivative suits. These are suits filed by shareholders against a director or office on the company's behalf. Shareholders may allege that the director or officer has committed acts that have harmed the company.
Limit and Retention
A D&O policy normally includes a single aggregate limit. Note that defense costs reduce the limit. The limit applies to damages and defense costs paid as a result of all claims made during the policy period.
A retention typically applies to indemnification and entity coverage (Side B and Side C). This is a specified amount that the insured must pay for each claim. The retention applies to Side B coverage if the corporation fails to indemnify a director or officer for any reason other than the corporation's insolvency.