D&O liability insurance

October 2011 » Columns » BEYOND WORDS
Jeffrey W. Cavignac, CPCU, ARM, RPLU, CRIS

Directors and officers (D&O) liability insurance increasingly is becoming a necessary part of businesses' arsenal in their attempt to defend themselves against the threat of litigation in the course of carrying out their official duties. D&O liability insurance covers a company's directors, its officers, and usually the company itself for liability arising out of the management of the corporation. These policies also cover the defense of a covered lawsuit.

Generally, lawsuits against directors and officers will allege negligence or breach of duty in the performance of the directors' or the officers' responsibilities on behalf of the company. While this is considered mandatory coverage for a publicly held or non-profit entity, it is also becoming more popular for privately held companies for the simple reason that the cost is reasonable, the coverage is fairly broad, and lawsuits typically covered by a D&O policy have been increasing.

Public companies' largest exposure arises out of securities class action suits. These suits typically allege things such as failure to disclose or accurately disclose certain relevant facts. Other types of suits include allegations that there was breach of fiduciary duty, or breach of contract.

In addition, both private and public companies can face lawsuits from other sources such as the following:

  • Employees may allege wrongful termination, discrimination, or harassment. These claims generally are covered by an Employment Practices Liability policy.
  • Clients and customers may claim breach of contract, failure to deliver services, poor product performance, or misleading statements or business practices.
  • Competitors may allege unfair trade practices, interfering with a contractual relationship, antitrust violations, or intellectual property infringement.
  • Fellow directors, minority shareholders, and debt holders may claim breach of fiduciary duty, mismanagement, or acting against the best interest of the company.

Non-profit organizations have a unique set of potential claimants, including the following:

  • Donors and beneficiaries who can claim misuse of donated funds or misrepresentation.
  • Third parties such as suppliers or providers and even other non-profit entities may allege interference with a contractual relationship, infringement, or breach of contract.
  • Government regulators could claim misappropriation of funds or violation of laws.
  • Volunteers may claim discrimination or harassment.

D&O liability insurance provides coverage to the individual directors and officers (Side A), the company for its obligation to indemnify the directors and officers (Side B), and the company itself if it is sued (Side C; Entity Coverage). The policy also covers the legal expenses associated with the defense of a covered suit.

A relatively new coverage also is offered called Side A Excess coverage. It provides additional protection to directors and officers when recoveries under the traditional D&O programs are unavailable because of company bankruptcy, when the company is prohibited by law from indemnifying its directors and officers, if the event is excluded under the standard policy, or if the limits under the primary policy have been exhausted. While the coverage under a D&O policy is fairly broad, there are exclusions. Generally, exclusions are included because the circumstance would be covered under a different insurance policy, or it is considered against public policy. While all policies differ, common exclusions include liability arising out of bodily injury or property damage, employee dishonesty, ERISA violations, fraud, pollution, and professional services. There also are insured-versus-insured exclusions, which need to be evaluated. Directors also should be aware that courts occasionally rule that directors are personally liable for their conduct and are not to be indemnified by the company or its D&O insurers.

D&O liability policies are written on a "claims made and reported" basis and only cover claims made when the policy is in force. If a company shuts down or is acquired, there are generally options to extend the reporting period into the future. These policies also have a retroactive date. This is the date before which actions would not be covered regardless of when the claim is brought.

Defense costs are included in the limit of coverage and will reduce amounts available to pay a judgment or settlement. These need to be taken into consideration when deciding on a limit. Although there are no hard and fast rules on what limit is appropriate, a general rule of thumb for a mid-sized public company is to purchase a limit equal to no less than 5 percent of the company's market capitalization. For privately held companies, a minimum might be limits equal to no less than 10 to 20 percent of a company's net worth, but no less than $1 million.

D&O liability policies are complex. Businesses and non-profit organizations should deal with a D&O specialist broker and also have their corporate counsel review the proposed coverage.

Jeffrey W. Cavignac, CPCU, ARM, RPLU, CRIS, is president of San Diego-based risk management firm Cavignac & Associates (www.cavignac.com).


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