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D & O Coverage Has Become A Necessity

Written By: Richard a. McGrath, CIC, LIA

The most important purpose of insurance is to protect against catastrophic risk – and few risks are as potentially catastrophic as those faced by company directors and officers.

Shareholders, customers, regulators, competitors, creditors, employees and special-interest groups are suing directors and officers for misrepresenting financial information, engaging in unfair trade, insider trading and more.  Some such suits are warranted, of course, but many are not.

Settling such suits can be costly and may even bankrupt a company or an individual.  Suits by disgruntled shareholders, for example, resulted in an average settlement of $38.39 million in 2006, with 12 settlements exceeding $100 million, according to a presentation to the National Directors Institute by Foley & Lardner LLP.

As recently as the 1960s, few companies carried directors and officers liability insurance.  Given today’s risks, D&O coverage, as it is commonly called, is a necessity.  D&O covers damages, costs of litigation or both when directors or officers are sued for wrongful acts while carrying out their corporate duties.  Claims may be payable to the directors and officers, or to the corporation itself.

Directors and officers have a legal duty to represent the interests of shareholders, as well as other corporate constituents, and must fulfill three essential duties:

  • Duty of Diligence.  Requires that directors act in good faith, consistent with what a reasonable and prudent person would do.  Before making important decisions, directors should review all information available to them.  They should also monitor corporate activities.
  • Duty of Loyalty.  Directors and officers should avoid engaging in personal conduct that would harm or take advantage of the corporation, such as insider trading of stock.
  • Duty of Obedience.  The conduct of directors and officers, and of the corporation, must conform to regulatory requirements and to the corporate charter.

Today, directors and officers of companies ranging from the smallest private companies to the largest public companies have to worry about lawsuits from many different sources.  Just a few examples of risks faced today include:

Global warming.  If a group decides your company contributes significantly to global warming, it may try to make an example of you.  A jury trial could be especially costly.

Americans with Disabilities Act (ADA).  Failure to have the proper curb cuts, elevators and other access needed by those with disabilities can result not only in fines under the ADA, but in legal action against company officers and directors.

The Family and Medical Leave Act (FMLA).  FMLA requires employers to take an extended leave and have their job waiting for them when they return.  If the act’s provisions are violated in any way, costly litigation may result.
D&O coverage is needed not only to protect the company and its executives, but to attract and retain talent.  Highly skilled directors and officers typically will not join a company unless D&O coverage is provided.  D&O is often coupled with employment practices coverage, which includes coverage for wrongful termination, sexual harassment and discrimination suits.

Of course, not all D&O coverage is alike and costs vary significantly, based on what is covered.  It is best to work with an expert who can determine the areas of greatest risk for your company and to have a clear understanding of exactly what is covered.

Policies differ significantly from one carrier to another.  Some policies cover punitive damages and some do not.  Some cover the costs of regulatory investigations and others do not.  Some insure the individual, others the corporation and others still insure both.

It’s important to have a complete understanding of what is covered.  Pay special attention, for example, to the “severability” clause.  A D&O policy can be rescinded if an employer fails to disclose important facts.  The severability clause determines whether the entire company loses coverage or only those responsible for the misrepresentation.
Not having D&O insurance can be a costly mistake for any company.  Having D&O insurance that doesn’t provide coverage when you need it can be an even costlier mistake.

When considering covering your business with D&O insurance options it is imparitive that Errors & Omissions Insurance is also considered and an expert in such area is consulted.

Richard A. McGrath, CIC, LIA is President and CEO of McGrath Insurance Group, Inc. of Sturbridge, Mass.  This article is written for informational purposes only and should not be construed as providing legal advice.

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