How Well Do You Know Your D&O?

By Richard K. Updegraff | May 11, 2012

Directors and officers (D&O) insurance is a form of liability protection available to persons who agree to serve as directors, officers and even employees of business entities to guard them from liability and costs of defense that may arise from claims made by persons who feel aggrieved by their actions while doing business. There are several important points for boards to consider as they evaluate different D&O insurance policies.

D&O insurance helps protect the personal net worth of those individuals who are involved in the management of the company. It is important to recall that the liability imposed upon directors and officers is personal. In many states it can be joint and several, that is, all defendants are equally liable and, therefore, each bears the entire risk, not simply a proportionate share. This insurance also protects the company from certain claims made against the directors and officers that the company has agreed to indemnify.

Most D&O policies are claims-made contracts. A frequent misconception is that companies that are not publicly traded do not benefit from D&O insurance, while, in fact, many cases have arisen from disputes involving private companies. Directors and officers of private companies face the same liability as those on public boards, usually with fewer alternatives available to disgruntled plaintiffs. In addition, private companies generally have less capability to indemnify and protect members of their boards. Some of the largest claims that have occurred in the past several years have been within the context of privately owned companies with few shareholders. 

In addition, some persons believe they are protected by what is known as the “business judgment rule.” While this court-created doctrine protects directors and officers from liability for misjudgments made in good faith, it is not an all-inclusive immunity. Directors and officers must first show they acted in good faith and not in their own self-interest. When dealing with smaller companies, with few owners, it becomes very difficult to distinguish the line between the company’s interest and the individual investor/board member’s interest. For these reasons, the protection of directors and officers liability insurance is just as vital for smaller private companies as for larger publicly traded ones.

One of many differences in policies relates to an indemnity policy versus a reimbursement policy. Under an indemnity policy, the carrier is obligated to pay loss and to advance defense costs. Under a reimbursement policy, the carrier is obligated to reimburse the insured as the claim proceeds. The indemnity policy is much more favorable to the insured.

One of the most widely divergent insuring clauses relates to claims based upon the offer and sale of securities of the company. For companies just beginning to raise capital and get organized, the coverage with respect to the sale of securities is paramount. Once companies have been operating for some time, the risk shifts from securities liability to operational liabilities. There are some insurance policies that provide coverage for all securities offerings. These policies are few in number and are the most expensive. Another type of policy provides coverage for securities offerings that are exempt under the Securities Act of 1933 that is acceptable for companies considering only such securities. If, however, the company intends to participate in the sale of nonexempt securities, then the policy needs to provide appropriate coverage to protect against claims related to registered offerings. Some policies obligate the carrier to give a quote for coverage of other securities claims; other policies are strictly limited to those exempt under the 1933 Act.

Some policies exclude coverage for any securities claims. Those polices should be avoided. Other variations include:
• Coverage for punitive damage claims.
• Exclusions if there has been a “final adjudication” of deliberate misrepresentation.
• Limitations on refusal to accept settlements.

Because each carrier writes its own D&O coverage with no uniformity among policies, it is vital to consult an attorney to determine whether the coverage is adequate. Directors and officers protection is not something that should be overlooked simply because of the belief that nothing will ever go wrong.

Author: Richard Updegraff
Attorney, BrownWinick Law Firm
(515) 242-2413
updegraff@brownwinick.com