Considering D&O Insurance

In the business world, the term, Directors and Officers (D&O) Insurance, is often heard, especially in companies working to form its first board of directors or working to bolster its current board. This article lays out, in question-and-answer format, several key issues for entrepreneurs to think about when considering buying D&O insurance.

What is D&O insurance and why is it important?

D&O insurance provides coverage to a corporation’s officers and directors for claims against them where

the corporation is unable to indemnify them under state law;
the corporation is financially unable to indemnify them; or
the corporation does not by agreement, its articles or its bylaws, provide for indemnification of the directors and officers.

Without adequate coverage or if the corporation does not have sufficient assets, directors and officers can be held personally and financially responsible for litigation costs and settlement or judgments in lawsuits filed against them as members of the board or as officers of a corporation. The legal fees and costs in defending even frivolous lawsuits can run into the hundreds of thousands of dollars. D&O insurance is primarily important in recruiting directors and officers to a company’s board and for the purpose of providing them with a financial cushion against any claims.

With the enactment of the Sarbanes-Oxley Act of 2002 and the change in how corporate officers and directors are viewed by the general public, there is a renewed emphasis on the responsibility of individuals serving in these positions. This renewed emphasis on responsibility, coupled with greatly expanded duties and obligations of directors and officers, results in a much higher risk than at any time in the recent past.

What are the primary exposures faced by D&O?

Directors and Officers face personal liability if their individual or collective actions result in financial harm to the company when they

breach their duty of care;
breach their duty of loyalty;
act for their own benefit;
act in such a way as to cause harm to the company;
commit a crime or wrongful act in their capacity as a corporate officer or director; or
misappropriate corporate assets for their personal benefit.

A determination of whether they have committed one or more of these acts will be viewed after the fact. Some of the many questions that will be asked are

whether the director or officer conducted a reasonable investigation in order to make an independent decision before taking a particular action;
whether the director or officer reasonably relied on information provided by others;
whether the officer or director knew or should have known his action was illegal or harmful to the corporation.

The answers to these types of questions will be generally viewed by a jury of one’s peers in court.

When do companies go “bare”? When do companies consider purchasing D&O Insurance?

While “going bare” is never a good idea, it is sometimes a financial necessity. Companies may consider going bare when it has significant assets to “self insure,” it does not have the funds or assets to afford D&O insurance, or all shareholders and employees are also officers and directors.

Companies should consider purchasing D&O Insurance as soon as the purchase is financially feasible and only when the company has shareholders who are not officers or directors or when the company is recruiting outside directors.

What is the approximate annual cost for a start-up or early-stage company?

The cost for D&O insurance is both company- and market-specific. This is an ever changing and evolving market with new insurance products coming to the market on a regular basis. In addition, the premium can vary significantly depending upon the type of coverage, policy limits, and endorsements.

In one recent experience, a start-up company paid $10,000 for $2,000,000 of coverage. However, the premium and coverage are dependent on such a significant number of variables that it is impossible to give an estimate without addressing each of these variables.

How should officers and directors of start-up companies commence the process of considering the purchase of D&O Insurance?

They should

Seek advice from insurance brokers, consultants, accountants, and attorneys familiar with the details of this type of policy and current market conditions.
Determine the amount of coverage desired and the amount of premium the company can afford.
Analyze how the coverage is “shared” between the officers, directors, and corporation.
Consult with their attorneys to determine if the company’s articles and bylaws provide the maximum amount of indemnification allowable under state law.
Examine the laws of their state of incorporation to determine whether the state law is favorable to directors and officers.
Review the D&O insurance policies from a number of insurance companies to determine the extent of the coverage available and under what circumstances the insurer is not obligated to provide coverage. Key questions to ask include: does it provide coverage for litigation defense costs and are these costs in addition to or deducted from the policy amounts?

Editor’s Note : The information in this article is provided for educational and informational purposes only. This information does not provide legal or other professional advice and is not the substitute for the advice of an attorney. If you require legal advice, you should seek the services of an attorney familiar with your specific legal situation and the laws of your state.