Many growing private businesses and non-profit organisations think that directors’ and officers’ insurance isn’t necessary, simply because they believe that the only realistic source of liability to an officer or director can come from a disgruntled shareholder. However, lawsuits by shareholders are only a portion of all lawsuits brought against officers and directors. There are many different types of lawsuits brought by other parties, such as customers, employees, competitors, vendors, creditors and regulators. All of these exposures exist no matter the number of shareholders the business has, and regardless of whether it’s private, public or non-profit.
That being said, there are many exposures that are potential liabilities to the personal assets of D&Os of non-profit and privately-held companies and organisations, which can extend to the personal assets of their estates and spouses. And that’s exactly why directors and officers insurance is a necessity. The legal standards of conduct for D&Os of non-profits and privately held companies are the same as those of publicly held ones. All D&Os are subject to three basic duties – loyalty, obedience and diligence. Breaches of any of these duties can lead to claims.
Although a company’s by-laws can provide some type of insurance to its directors and officers, there are many situations where corporations are unwilling or unable. For instance:
- Inability to insure due to insufficient cash flow or financial insolvency;
- Unwillingness to insure due to corporate takeover or a new management team;
- Derivative claims that are brought on behalf of the corporation where insurance isn’t permitted;
- Interpretation of “good faith” where the corporation isn’t obligated to insure the directors and officers if the liable director or officer didn’t act in “good faith”;
- Agreement not to indemnify for certain acts, such as intentional misconduct and alleged fraud.
Private companies and non-profit organisations, as aforementioned, are exposed to claims by the following.
- Employees who can claim discrimination, harassment and wrongful termination against the D&Os, as well as the company itself. A properly tailored directors and officers insurance can cover these claims against the insured individual or entity;
- Clients, customers and consumer groups who claim a violation of civil rights, harassment, discrimination, misleading statements, contract disputes and false advertising;
- Competitors, contractors and suppliers can file claims for unfair competition and anti-trust violations that can result in infringement of patent, trade secrets, trademarks and lost business by the competitor;
- Claims by third parties that can vary from those relating to employee safety and health to environmental contamination. In addition, non-profit and privately held corporations can face claims and investigations by regulatory agencies for suspected or actual wrongdoing;
- Lenders, shareholders, bondholders or other investors can make claims for inaccurate or inadequate disclosure and alleged misrepresentation in financial reporting. Since there’s a lack of availability of private companies’ financial data, stakeholders rely on statements and materials made by the private company itself. Other types of claims can include breaches of the duty of care in terms of how the D&Os handle the sale of the business or how they missed a great opportunity for the business. Breaches of the duty of loyalty in terms of deals the business enters into with other companies owned in part or in whole by one or multiple D&Os;
- Mergers and acquisitions that include claims like disgruntled stakeholder suits, misleading statements or alleged financial misstatements about the business’ revenue market share/sources, bankruptcy from a failed transaction, failure to perform due diligence when making the acquisition of claims from past vendors and/or creditors of the acquired company;
- Corporate governance and succession planning claims. Since many private companies have founding members or are run by family members, this can lead to proxy disputes, legal disputes among family members, poor succession planning which may cause leadership disputes or vacuums in case of a sudden change in leadership due to sickness or death.
So why do non-profit and private companies need D&O insurance?
- To get coverage from claims against the personal assets of D&Os, their estates and spouses;
- To protect the balance sheet and income statement of the company;
- To retain and attract qualified outside directors and officers;
- To avoid shifting management attention to costly and protracted litigation;
- To establish a professional relationship with insurers before a potential IPO (initial public offering).
In conclusion, non-profit and private company directors and officers liability insurance afford coverage to the executive officers, the board of directors and employees of a business for claims made against them. These policies further provide coverage to the corporate entity for purported negligence, breach of duty, misstatement, error, misleading statement, omission in the performance of their duties to manage the business.
Oftentimes, non-profit and private company D&O insurance policies include a wide spectrum of coverage for claims involving violations of employment practice laws, hence minimising the need for a stand-alone employment practice liability policy. Coverage provisions and program limits should be assessed on a yearly basis.