A common misconception about directors' and officers' (D&O) liability coverage is that it is only for large, publicly traded organizations needing protection from shareholder suits. This notion could not be further from the truth. A recent study by Chubb Insurance found that 43% of D&O lawsuits came from customers and 29% from regulatory agencies. Interestingly, stockholders accounted for only 11% of all D&O claims. To get a better understanding of the importance of this type of liability coverage and how it can be used to protect your personal assets, we recently spoke with Bruce Rogers, Regional Director of Insurance First Niagara Risk Management, a subsidiary of First Niagara Bank.
CBIA: Why do you think it's essential for all businesses, regardless of size or corporate structure, to consider D&O coverage?
Bruce Rogers: The biggest reason is that without this insurance, directors and officers run the risk of having to pay legal defense, settlement, and judgment costs out of corporate or personal assets. Defense costs alone can create significant financial burden that can strain or bankrupt a company. Some of the more common claims that put directors and officers at risk are: competitors bringing anti-trust or unfair competition claims; regulatory agencies launching costly investigations; creditor and bankruptcy claimants seeking restitution against owners and boards; and shareholders in private companies suing for inadequate or inaccurate financial disclosures and statements made in private placement materials.
In any liability suit, there is exposure for a director or officer's family. Claims could be made against his/her spouse or their estate, and family members could be held personally liable for expenses associated in settling a claim against the company. D&O insurance eliminates the potential burden of legal fees and restitution on a director or officer's family or estate.
CBIA: Why are family businesses possibly more susceptible to D&O suits?
Bruce Rogers: In many instances, family businesses have difficulty finding truly objective board members, or they have no formal board of directors at all. Consequently, family members with an ownership stake (often gained through inheritance), but who are not involved in the day-to-day operations of a business, may question decisions made by those in charge and bring a suit for mismanagement of the business or diminution of their asset. For example, let's say there is a relative whose only involvement in the business is ownership of shares, and they lose value. If this person believes that the loss is the result of a perceived mistake by management, they could take legal action. Mergers and acquisitions (M&A) are a very common trigger for litigation. Minority shareholders may not want to sell or may believe that the majority shareholders gained disproportionate benefits from the sale. Claims may also result from misrepresentation during M&A activities or from acquisitions that do not ultimately pan out as expected. We've seen suits from disgruntled minority owners claiming that their sibling, who was running the company, "squandered" the asset that a prior generation left in his/her hands. These are just a few examples of the types of claims that are frequently made against family businesses.
CBIA: When a private company decides to buy D&O insurance, what are the factors they should take into consideration in determining their coverage needs?
Bruce Rogers: It's difficult to generalize since each business has its own specific needs. This is where the guidance of an experienced broker is essential in selecting coverage. That being said, some of the most important factors to consider are: the company's reliance on debt financing; whether there is a plan for succession of management or ownership; the percentage of ownership in the hands of non-management; the quality of the relationship with investors and creditors; future M&A plans; and whether the company is in a line of business susceptible to significant regulatory oversight.
CBIA: What additional advice can you give us in selecting the appropriate type of D&O coverage?
Bruce Rogers: A D&O policy is not like an auto insurance policy, which contains fairly standard policy language. D&O insurance is developed with the needs of the particular business in mind. Businesses need a broker who understands their unique operating structure, their industry, and their future plans for growth and expansion. D&O policies need to be carefully customized, and business owners need to be appropriately counseled to ensure they understand the situations or conditions that put their company at risk and the way the policy will respond when a claim occurs. For example, focus should be placed on the specific definition of claim, policy exclusions, the option for choice of counsel to represent the insured party, and the role they can or cannot have in the decision for settlement. Because of the uniqueness of various D&O policies, businesses need a broker who understands these nuances and is able to advise them on the particulars of their coverage so they can choose a plan that will safeguard their company, their loved ones, and the future of their business.
Bruce Rogers, is the Regional Director of Insurance First Niagara Risk Management. He has over thirty years of experience in the insurance and risk management industry. He can be reached at 203.854.3406 or email@example.com.