Directors & Officers (commonly referred to as D&O) Liability Insurance can best be understood as “decision making insurance.” Anyone at the company who makes management decisions could be sued if a third party believes that they have been harmed by decisions that have been made.
Normally we associate D&O coverage with nonprofit organizations. Most people instinctively understand the need for coverage to protect those who volunteer their time to serve on the board of a nonprofit organization. If something goes wrong and the board is sued for decisions they’ve made on behalf of the organization, the volunteers shouldn’t need to fear that their personal assets will be at risk.
Likewise, it’s easy to understand why publicly traded companies need D&O coverage, as they have shareholders who are more than willing to sue the company when things go wrong and the stock price falls.
But why would a private company without shareholders need D&O coverage?
It’s a reasonable question to be sure. But there are also very reasonable answers. Let’s consider a few of them.
1.) Shareholders are not the only ones who can be harmed by actions of the company. Others can include:
- Governmental and Regulatory Agencies
- Competitors
- Suppliers/Vendors
- Customers
- Creditors
- Potential M&A partners
Any of these can bring a suit against the company if they believe that they have been harmed by acts or decisions made by management. Legal action brought by a government or regulatory agency can be particularly difficult to predict and very expensive to defend against.
2.) Trade Secrets: If you hire an employee who was in a key position with a competing company, the competing company may file suit alleging improper use of proprietary information or trade secrets.
3.) Mergers & Acquisitions: If your company is engaged in mergers or acquisitions, even in an exploratory way, there is risk for D&O claims. The risk can include allegations of misrepresentation, financial misstatement, and financial damage caused by a failed transaction.
Other possible claims for a privately held company can include fraudulent misrepresentation (often from a financial institution), breach of a noncompete agreement, deceptive trade practices, vendor lawsuits, or tortious interference.
What’s important to keep in mind is that when a lawsuit is filed you have to defend yourself—even if you’ve done nothing wrong.
Without insurance, you will be forced to bear the cost of defending yourself—and, for many D&O claims, defense costs can be significant and potentially crippling to your business. For a privately owned business, D&O claims are certainly not frequent, but when they happen they can be severe. Carrying D&O coverage, generally inexpensive, is a worthwhile consideration when the alternative may be financial ruin.