Directors and Officers Liability Insurance

Board meeting
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Directors and officers (D&O) liability insurance protects corporate officers and directors from claims alleging they performed their duties improperly. You should consider this coverage if your company is a corporation. Lawsuits against board members and company officers can generate large awards against the individuals themselves or the company.

What is a Corporation?

A corporation is a legal entity that is owned by shareholders and governed by a board of directors. The directors are elected by company shareholders. The board appoints officers to manage the company's day-to-day affairs. They typically include a chief executive officer or president, a chief financial officer, and a secretary. Some companies have additional positions, such as a chief information officer or a chief human resources officer.

Liability of Directors and Officers

Directors and officers are liable for negligent acts or errors they commit while serving the corporation. In some cases, they can be held personally liable for the plaintiff's injury. This means that their personal assets may be used to satisfy the plaintiff's demand for damages. The fear of personal liability can hinder a company's ability to recruit new officers and directors. The company can quell those fears by purchasing  directors and officers liability coverage.

A corporation is vicariously liable for negligent acts or errors committed by directors and officers while performing their duties on the corporation's behalf. Thus, a corporation is subject to suits by third parties for injuries they have sustained as a result of acts committed by a director or officer.

Stockholders are essentially silent owners of a corporation. Because they have no say in the way the company is operated or managed, stockholders cannot be sued as a result of negligence or wrongdoing committed by officers or directors.

Suits Against Directors and Officers

Corporate directors and officers have duties to the corporation, stockholders, employees, creditors, and government entities. They are obligated to act with care, loyalty, and obedience when carrying out their duties on behalf of the corporation. They must be honest when disclosing details about the company's financial condition to stockholders and creditors. They must treat employees fairly and comply with government regulations. If they fail to fulfill these duties, directors and officers may be sued.

Here are examples of acts that can lead to lawsuits:

  • Inaccurate statements made to investors, lenders, vendors or customers about the firm's  current financial health
  • Wrongful termination, discrimination, or harassment of a former employee
  • Mismanagement of the company's finances, which caused the value of the firm's stock to decline   
  • Initiation of a merger or acquisition without conducting due diligence
  • Misstatements regarding the future financial performance of the company
  • Misappropriation of a competitor's trade secrets
  • Insider trading

Indemnification

One concept central to D&O liability insurance is indemnification. Indemnification occurs when a company reimburses directors or officers for the cost of damages and defense expenses that result from lawsuits. If these individuals had to pay these costs out of pocket, few people would choose to be officers or directors. Thus, most states permit corporations to indemnify directors and officers. States prohibit indemnification under certain circumstances, such as when a director or officer has been convicted of a crime.

Many states allow corporations to decide the extent to which they will indemnify officers and directors. These decisions are often incorporated into a firm's bylaws.

Directors & Officers Insurance

Directors and officers liability (D&O) coverage is a type of errors and omissions insurance. It protects directors and officers from lawsuits filed by shareholders, regulators, state investigators, or other third parties.

D&O policies are designed to cover claims seeking damages for financial injuries, not bodily injury or property damage. They cover third-party claims for financial losses sustained due to an error or omission committed by a director or officer. Most D&O policies provide the following three types of coverage:

  • Directors and Officers Liability. Covers damages and expenses assessed against a director or officer who has not been indemnified for these costs by the corporation. This coverage is often called Side A. It protects directors' and officers' personal assets. A company may be unable to provide indemnification because it is bankrupt or because it is barred from doing so by law. States generally prohibit indemnification of directors or officers who are the subject of a derivative suit (a suit filed by shareholders on the company's behalf).
  • Indemnification. Reimburses the corporation for funds it has paid to directors or officers or on their behalf as indemnification. Often called Side B coverage.
  • Corporate Liability. Covers claims or suits filed directly against the corporation. It is often called Side C or Entity Coverage. The scope of this coverage varies depending on whether the insured company is a private, public, or non-profit corporation. If the insured company is a public corporation, entity coverage usually applies only to securities claims.

     D&O policies are claims-made, meaning they cover claims made during the policy period. Claims made after the policy expires aren't covered. Many policies include the option to purchase an extended reporting period, which covers claims reported after the policy has expired. Some policies include coverage for employment-related practices like discrimination and wrongful termination. If this coverage isn't included in the policy, the insurer may offer it under a separate employment practices liability form.

    Specialized Policies

    Many insurers that offer D&O coverage have developed specialized policies for certain types of businesses. An example is a Private Company D&O policy, which is designed for corporations whose stock is not publicly traded. Specialized policies are also available for non-profit organizations, financial institutions, healthcare companies, and educational institutions.

    Article edited by Marianne Bonner