Jury awards and settlements against directors and officers of companies in the U.S. have increased dramatically, largely due to federal securities class-action lawsuits.
But while small and mid-sized business owners often safely believe they won’t be targeted by those kinds of lawsuits, directors and officers of privately held companies can also be sued, leaving their personal assets at risk. While it may be hard to fathom any action that could imperil your assets, it can happen with the right kind of lawsuit.
Unfortunately, many small and mid-sized business owners, while insuring their businesses, often overlook their own liability. This protection gap can be covered with directors and officers (D&O) liability insurance, which protects company leaders from litigious employees, competitors, investors, vendors – and even customers.
Directors and officers can be held personally liable for civil, criminal or regulatory proceedings should they fall short of their obligations, and their personal assets – such as cash, property and pensions – could all be at risk.
Some small-business executives believe that their general liability or umbrella business insurance policies will cover claims involving directors and officers. But typically, those policies don’t respond to management liability lawsuits.
And often, owners of small businesses may not have the same level of understanding of what their responsibilities are in terms of complying with legislation and regulations, as perhaps large employers would.
For smaller firms, who typically have fewer resources to defend allegations or fund potential fines, penalties or awards for damages, D&O is becoming an increasingly important coverage.
One in eight owners of small businesses surveyed Chubb Group reported having been sued in the previous five years. The average damage from the lawsuits was $225,682 in losses. Some suits cost much more, with losses approaching $5 million.
The typical action that would trigger a D&O policy would allege that management committed some wrongful acts. Some common D&O claims for small and mid-sized entities could include:
- False advertising (even if it’s a frivolous allegation).
- Unfair competition claims that may include copyright infringement allegations.
- Not complying with regulations and laws.
- Employee-driven lawsuits alleging management allowed harassment or discrimination despite knowing about it.
- Suits by investors about decisions concerning mergers and acquisitions.
- Allowing misleading information in a company prospectus.
What D&O covers
One of the most important aspects of a D&O policy is that it’s a protection against the costs of frivolous lawsuits.
D&O covers court costs and lawyers’ fees if a business becomes the target of regulators, or even a criminal investigation. But the policy will not shield managers if they commit fraud or participate in crime.
That said, if one board member is convicted of fraud while the other board members are innocent, a policy could still cover the legal costs of those who did no wrong.
D&O policies come with different deductibles for the different “sides” of the policy.
Side A – Known as the “personal protection” part of the policy, this indemnifies directors and officers if the company is unable to do so.
Side B – This part reimburses a company if it pays the legal bills of its directors and officers due to an action against them in their company capacity. Side B responds most commonly in the majority of claims brought against directors and officers.
Side C – Known as “entity coverage,” this part covers a company if it is sued alongside any directors and officers.
Sometimes it’s best to mix and match coverages based on your organization-specific risks. For some companies, a Side A will do.
We can evaluate and review the coverages and policy language associated with D&O insurance for you to find a policy that best suits your organization and board.
Cost of coverage
Fortunately, there are a number of low-cost D&O policies available for small businesses. The premium for $1 million worth of coverage is typically really afforadable.
Final thoughts: Sometimes you will have to purchase a policy. For example, many directors and officers may refuse to take on a position without the coverage. Often times you need the coverage because the exposure is there.
And if your business wants to attract new funding, most institutional investors require the protection.