How to Protect Directors & Officers from Lawsuits
Imagine these scenarios affecting organizations of varying types and sizes:
- Members of a trade association sue the group's board of directors, accusing them of mismanaging association funds by spending thousands of dollars on a project that went nowhere.
- Stockholders in a small restaurant chain sue the company's risk management officer after a location suffers a total uninsured loss of the building, contents and food.
- A taxpayer group sues a public library's board of trustees for building up a reserve fund that the group considers to be too large.
All of these scenarios could mean large financial losses for the organizations and the individual directors. They need directors and officers (D&O) liability insurance to pay for these situations if they occur.
D&O insurance covers corporate managers for claims that result from management decisions that have negative financial consequences. Unlike general liability insurance, it does not cover bodily injuries or property damage; rather, it covers decisions that result in lower revenues, higher debt, lost profits, and similar losses. It also may cover suits resulting from mistakes made in regulatory or tax filings for which the company must pay fines.
Insurance companies provide this coverage on a "claims made" basis. Unlike traditional general liability insurance, it applies to claims first made against the insured organization during the policy period, but only if the "wrongful act" (the term the policies typically use) occurred on or after a "retroactive date" entered on the policy's information page. For example, a policy that has a term of January 1, 2017 to January 1, 2018 and a retroactive date of January 1, 2012 will cover lawsuits arising from wrongful acts committed on and after January 1, 2012, but only if the claims are first made during 2017. The organization may have additional time to report claims after the policy expires if it is not renewed.
Another difference from traditional liability coverage is that the cost of defending claims reduces the amounts of insurance available to settle them. If the policy provides $10 million in coverage and defense costs use up $1 million, there will be only $9 million to settle the claim. In traditional policies, defense costs are covered in addition to the available amounts of insurance.
D&O insurance covers suits arising from legitimate business decisions and employee complaints of unfair treatment or harassment. It does not cover criminal or fraudulent acts or acts that the perpetrators intended to be harmful. However, it does cover innocent officers and directors who are sued because of their colleagues' misdeeds. For example, if the entire board is sued because one member embezzled funds, the insurance will protect the innocent board members but not the embezzler. It will also not cover officers and directors who improperly use their positions for personal gain.
D&O insurance is often thought of as a coverage for large businesses. However, small
corporations, non-profits, charitable organizations and public entities face these types of lawsuits as well. Every organization that has employees or investors should consider buying this coverage.
Thank you for visiting the Partners Insurance Agency blog. We hope you found our content helpful and informative.