Why Private Companies Need D&O Insurance Too
Private corporations and nonprofits are less likely to be targeted in multi-million dollar directors and officers liability lawsuits than publicly traded companies. They still have risk exposures, though. In fact, in a recent survey by Advisen, 25 percent of D&O claims among private companies settled for $1 million or more. Could you protect your directors and officers from claims that large?
Directors and officers liability insurance, commonly known as D&O, protects corporate directors and officers from liability arising from acts or omissions they commit in the course of their official duties. Directors and officers owe the corporation they serve, and its shareholders, three fiduciary duties: the duty of care, or of acting with reasonable prudence in the performance of their duties; the duty of loyalty, or of putting the corporation’s interests above their own; and the duty of obedience, or of acting within the scope of their authority. Directors who fail to carry out these responsibilities can be held personally liable if their errors or omissions result in a loss to the corporation or its shareholders.
In recent years, those “official duties” have become more onerous, due to increasing regulatory scrutiny. For example, in 2002, the Sarbanes-Oxley Act became law. In addition to tightening responsibilities for outside auditing companies, the law also placed greater financial oversight responsibility on a corporation’s principal executive and financial officers. These individuals must now agree in writing that they have personally reviewed the corporation’s annual or quarterly SEC filings and certify the information contained therein is true to the best of their knowledge. (The Dodd-Frank Act, which passed in 2010, has also increased responsibilities for directors and officers, but it primarily affects financial services companies.)
Publicly traded companies need D&O insurance to protect their directors and officers from the risk of shareholder suits. Privately held corporations have much lower exposures to shareholder suits. However, shareholders can—and sometimes do—sue directors and officers of private corporations.
Although nonprofits have no shareholders, directors and officers must manage the organization’s assets well and in accordance with the bylaws. Considering that some nonprofits have multimillion dollar budgets, their directors’ responsibilities can equal those of a publicly traded corporation. In fact, Sarbanes-Oxley’s executive liability and whistleblower protection provisions apply to nonprofits as well as to for-profit corporations.
Employees: A Private or Nonprofit Corporation’s Greatest Risk
Still, for nonprofits and privately held companies, employees present the greatest liability threat to directors and officers. The majority of D&O claims among nonprofits and private companies involve employment practices liability claims filed against the entity and its directors and officers. Employment practices liability claims involve employment actions, which can include:
- Wrongful termination
- Wrongful discipline.
To address this need, insurers have developed specialized policies for private corporations and nonprofits that combine D&O coverage with employment practices liability insurance, or EPLI.
It’s important to note that the D&O/EPLI policy covers only directors and officers—it will not cover managers or supervisors from employment practices claims. If you have significant employment practices liability exposures, you might need a separate EPLI policy.
Other Liability Exposures
That’s not to say that private companies don’t have exposures to shareholder lawsuits. According to a survey by Advisen, a company that provides information to assist in the underwriting, marketing and purchasing of commercial insurance, excluding employment practices liability claims, 46 percent of lawsuits filed against private companies participating in the survey were filed by shareholders, 33 percent were client-led, and 21 percent were vendor-led.
Private company shareholder suits most commonly involve claims from minority shareholders who claim the actions of majority shareholders benefitted themselves at the expense of minority shareholders. Companies planning merger or acquisition activity should protect themselves from this exposure.
The proper liability coverage can help your organization attract and retain qualified directors and officers. For a discussion of your risk exposures and analysis of your coverage needs, please contact us.
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In this issue:
This Just In...
Business Income Coverage: Survival Plan for Small Business
Why Private Companies Need D&O Insurance Too
What’s the Difference between Arbitration and Mediation?