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Understanding D&O Liability Insurance Coverage

Directors and officers (D&O) liability insurance covers a company’s directors and officers from allegations of mismanagement (Side A). Coverage also extends to the corporate entity’s responsibility to indemnify the directors and officers (Side B) and also can protect the entity itself for securities-related litigation (Side C). Additionally, these policies cover the defense of a covered lawsuit.

Side A excess coverage also may be offered. 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.

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 like 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.

Both private and public companies face lawsuits from other sources as well.

  • 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.

  • 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.
  • Volunteers may claim discrimination or harassment.

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. Insured versus insured exclusions also need to be evaluated.

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 generally are options to extend the reporting period into the future. These policies also have a “retroactive” or “knowledge” date. A retroactive date excludes coverage for any activities prior to that date. A knowledge date covers all activities regardless of when they took place so long as the individual signing the application didn’t have “knowledge” of the problem when the application was signed. A knowledge date is preferred to a retroactive date.

Defense costs are included in the limit of coverage and will reduce amounts available to pay a judgment or settlement. This needs to be taken into consideration when deciding on a limit. 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 percent to 20 percent of a company’s net worth, but no less than $1 million.

Because D&O liability policies are so complex, a company should work with a D&O specialist broker and have corporate counsel review the proposed coverage as well.

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