LIABILITY INSURANCE FOR BOARD DIRECTORS
An important consideration when joining a board is Director & Officer liability insurance, commonly known as D&O insurance.
Public companies purchase D&O insurance to protect directors and officers from the chance of getting sued by stockholders, vendors, competitors and other parties. These lawsuits can arise if directors or officers are accused of violating their duties to the stockholders or the law, particularly federal securities law. D&O insurance removes the personal liability risk officers and directors face from the law in the event that they make a bad business decision, unless that decision violates one of their specific duties.
Research from Harvard Business School finds that when companies are named as defendants 11% of their directors are also named as defendants. The chances of being names a defendant are much higher for directors serving on the audit committee–around 54%, and around 16% for directors that sold shares of the company. These odds are also increased for directors that have been on the board for an entire class period. In many cases directors being named as defendants is a strategic by plaintiffs to get larger settlements since it means the case is less likely to be dismissed.
Further, lawsuits may allege a breach in fiduciary duties to a corporation. These suits can either be brought directly or derivatively. In some cases, derivative suits are concerning because a company cannot indemnify its directors and officers to settle these suits.
Independent corporate directors named as defendants in D&O litigation rarely pay settlements or judgements out of their own assets. Corporations, not the individual officers and directors, are responsible for paying the deductible. The legal expense of defending directors or officers in court can be very costly, even if the ruling is in the director’s favor. Insurance provides protection by covering legal fees, settlements, judgments and other associated costs.
D&O liability policies cover current, past and future directors and officers. Coverage for past officers and directors is critical because lawsuits often arise after directors and officers leave or are terminated from their positions.
There are three sides of D&O insurance. Side A protects directors and officers from personal financial liability. Side B applies when the company bears losses due to indemnifying its officers. Part C covers the company when it is sued directly beyond the damages relating to indemnifying directors and officers. Additional coverage is available for purchase under a Broad Form Side-A DIC policy.
From a financial perspective, the largest threat facing public board directors and officers is a federal securities class action suit alleging that federal securities laws were violated. Such suits typically occur after a sharp decline in the company’s stock price.
Here are a few real-world scenarios that resulted in the filing of D&O lawsuits, as reported by The Hartford Insurance Company:
Breach of fiduciary duty: Investors sued a company alleging that some of the company’s officers had personal connections to a third-party contractor hired to re-tool the company’s assembly line. Thus, investors claimed that the officers hired the contractor to further their personal interests, not the interests of the company. Other officers and directors were alleged to have either knowingly colluded with one another or at least breached their duty of care in undertaking the project without properly investigating the qualifications of the contractor.
Noncompliance with workplace laws: A female employee was terminated. She sued the directors and officers and the company for wrongful termination based on gender discrimination.
Theft of intellectual property: A vice president left his firm to start up his own company. His former employer sued him and his new firm alleging that he took with him certain corporate licenses to market proprietary software, creating unfair competition and trademark infringement.
Misrepresentation: A company negotiated a large contract with a customer. The contract required the company to have certain financial and human resource assets in place to satisfy production and delivery requirements. The directors misrepresented the company’s revenues and capabilities, leading the customer to sue the company after it was unable to meet the terms of the awarded contract.
The information contained in this post is general in nature and should not be considered to be legal, tax, accounting, consulting or any other professional advice. In all cases, you should consult with professional advisors, familiar with your particular factual situation, for advice concerning specific matters before making any decisions.