Blueprint for Wealth
Wayne M. Zell, Esq.
Directors and Officers Liability Insurance
In my last column, I explored different types of liability insurance protection available to business owners. My business clients also commonly ask whether they should obtain special protection for managers, officer and directors, known as “D&O Insurance.” This type of liability insurance generally provides financial protection for the directors and officers of a company (and in some cases or the company itself) if they are sued in connection with their performance of duties for the company.
D&O Insurance is sort of like errors and omissions (E&O) coverage for the company’s managers, but it is not the same. E&O insurance generally covers liability for performance failures and negligence with respect to your products and services. It generally does not protect from a manager’s failure to perform his or her duties. Most companies are well-advised to carry both types of insurance.
You generally should consider buying D&O Insurance if you are planning on assembling a board of directors to help manage the company. Most savvy outside directors will demand that your company maintain a D&O policy. In addition, venture and private equity investors usually require D&O Insurance as a condition of making their investment, which usually requires a representative of the investing fund to be placed on your board. Interestingly, Ive heard that Warren Buffett, one of the savviest investors in the world, does not purchase D&O Insurance for the directors of Berkshire Hathaway, the massively successful holding company that owns businesses in the insurance, utilities, energy, railroad, retail, home furnishings and other industries, although the operating companies may purchase such insurance for their directors.
A well-crafted D&O policy will protect your directors and officers’ personal assets from the claims of stockholders, employees and customers. In particular, the policy should provide protection for employment-related claims (EPLI coverage), since nearly half of all claims against directors and officers originate in the employment arena. And, according to a 1997 survey conducted by Watson Wyatt Worldwide (now Towers Watson), nearly one-third of all companies could expect to have at least one claim made against its directors or officers, although that percentage drops significantly (to 12%) for companies with less than $100 million in assets.
Basic D&O coverage comes in two flavors with multiple add-ons. A-Side Coverage typically provides protection directly to the directors and officers for losses (including defense costs) resulting from claims made against them for wrongful acts. It generally applies where the company does not indemnify, refuses to indemnify or is not permitted to indemnify its directors and officers. B-Side Coverage typically reimburses a company for its losses where it indemnifies its directors and officers for claims against them. It does not protect the company for its own liability. Some D&O policies provide additional C-Side or Entity Securities Coverage to protect the company against securities claims, therefore providing protection for the company’s own liability (unlike B-Side Coverage).
As noted, employment practices liability insurance (EPLI ) is a major component of D&O Coverage today or it may be purchased under a separate policy. This coverage typically protects directors, officers, employees and/or the company against employment-related claims brought by employees and, in certain circumstances, specified third-parties. For example, it provides coverage for wrongful dismissals or failures to promote, sexual harassment, and other violations of federal, state or local employment and discrimination laws brought by the company’s employees.
The insured director or officer usually has the right to select his or her own lawyer if sued, but the insurance company usually has the right to consent to the insured’s choice of counsel. Although the insurance company generally cannot control the insured director’s defense, they only have to pay for “reasonable” defense costs arising out of covered claims. In addition, defense costs may be subject to specified limits or caps in the policy. So, the insured director and his or her lawyers do not have a blank check to run up defense costs.
When shopping for D&O Insurance, make sure you have a competent attorney experienced in D&O Insurance matters review the policy and its endorsements. The important points to review include how a “claim” is defined, what losses are covered, what matters are excluded from coverage (i.e., dishonesty, fraud or willful violation of law; insured vs. insured coverage), the dates on which coverage applies, and allocation of liability where the company is not covered and more than one person is involved in the claim. Combined risk policies are more prevalent today than ever before. These policies combine A-Side, B-Side, and entity securities coverage with EPL coverage, fiduciary liability coverage (e.g., for acting as a trustee of a 401(k) plan) and other coverage. In addition to the limits of coverage contained in all policies, the combination of risks, and the exclusions all factor into the overall premium costs and should be studied carefully before signing on the dotted line.