Taking a Second Look at
Director' & Officer's Liability Insurance

W. Meade Collinsworth CPCU, ARM, AIM, AAI

The common misconception of Director's and Officer's Liability Insurance is that it is intended principally for publicly owned organizations that issue shares of stock which are traded on one of several stock exchanges. Most of the insurance presently written is purchased by public type organizations. However, in recent years, many non-profit organizations have seen the need for this protection. In fact, a significant number of Boards of Directors and Officers have purchased this coverage and are now protected against suits emerging from their organization members and the public.

So why do we suggest you should take a Second Look? The answer to that question is not a simple one, but it begins with the awareness that the current trend of suits against the Directors and Officers of privately held corporations is expanding dramatically.

First of all, many Directors and Officers believe that the organization's Commercial General Liability and Umbrella policies cover corporate Directors and Officers for their acts of misconduct and malfeasance while acting on behalf of the corporation. Unfortunately, this is not true. In fact, the Commercial General Liability and Umbrella coverages specifically exclude these exposures, whether the insured is a publicly owned or privately held, as these policies are not designed to cover these allegations.

Directors and Officers of privately held corporations seem to hold a general consensus that their exposure to suits is non-existent or at worst, minimal. In actuality today, the opposite is true. Directors and Officers of privately held corporations are subject to suits from a variety of sources, which are not too different than the exposures to Directors and Officers of publicly held corporations.

Directors and Officers, whether private corporations or publicly owned organizations, are held to the same high standards of conduct as respects compliance with federal, state and local laws. Just because the shares of a privately owned corporation are not publicly traded on a stock exchange, does not exempt the Directors and Officers from meeting the same high standards and responsibilities of their counterparts in public organizations.

So what are some of the exposures to Directors and Officers of privately owned corporations?

• In addition to having to meet stringent legal requirements of federal, state and local laws... Directors and Officers of privately owned corporations are exposed to suits from stockholders for alleged failure to maximize the sale price of the corporation should the entity be sold to others.
• The allegation of mismanagement will primarily surface with an allegation the Directors & Officers made decisions which materially affect the share value of minority shareholders, or in some instances, employees.
• The allegation of mismanagement may also include the allegation, the Directors & Officers breached their fiduciary duty of care and loyalty by failing to secure a contract for goods or services arising from their duties to / for the organization
• Directors and Officers are exposed to suits from employees, even those that are not shareholders. An example would be a suit against the D&O's by an employee suing the corporation and alleging failure of enforcing the provisions of federal, state and local employment practices type procedures. Nothing prevents the employee from filing suit against the individual Directors and Officers as well as the corporation.
• As far-fetched as it may seem, Directors and Officers are exposed to potential claims from customers and even competitors and vendors. An Officer of the Corporation typically handles the negotiation and administration of contracts on behalf of the privately owned corporation. The Officer may have the responsibility for negotiating the contract, but may not have the full input and knowledge of the project's important elements resulting in a gross misunderstanding with the client, customer or vendor. Such lack of internal corporate communication may result in a suit by the customer, client or vendor against the Officer. It is not beyond the realm of possibility that a competitor may bring suit if an Officer of a privately owned corporation discussed the terms of a contractual relationship with a competitor.
• Governmental Agencies are another source of potential claims against Directors and Officers of privately owned corporations. Suits may emanate from allegations of environmental contamination, health, safety and welfare issues.
• Non-public corporations face investigations and claims from regulatory agencies with respect to suspected or alleged wrongful acts such as collusion in bidding and/or unfair trade practices. Non-public corporations are not only exposed to investigations or claims from regulatory agencies, but also from competitors, customers and even ex-employees.

There is a popular belief that the Directors and Officers of privately held corporations are protected by the corporation's reimbursement agreement with its Directors and Officers. There are potential problems relying upon this as "absolute" protection for the individual Director or Officer. Certain claims against individual D&O's may not be indemnified, by law, thus the reimbursement agreement is not triggered. Also how will the corporation "fund" these allegations / reimbursements?

As an example, how does a Director or Officer replace monetary loss to the corporation resulting from the Directors and Officers wrongful act that resulted in financial loss to the corporation? Were the corporation permitted to reimburse the Director or Officer for their wrongful act, it would defeat the purpose of the derivative suit and judgment against the Director or Officer. The suit's intent would require the individual Director or Officer to indemnify the corporation with their own personal assets, or assets from their spouse or estate. In this situation, the Directors and Officers insurance policy would reimburse the corporation on behalf of the individual director or Officer.

Finally.if the corporation was insolvent and judgments were awarded against the Directors and Officers of the corporation, most likely the funds would not be there to pay the claimants. Payment would, again, be made from the assets of the individual Directors and Officers personal assets, or from their spouse or estate. In a Directors' and Officers' liability policy, payment would be made on behalf of the Directors and Officers subject to the policy limits, terms and conditions.

Misconduct by Directors and Officers of public corporations have made the headlines in recent months. We only have to mention the names of several large publicly held corporations to make the point. Also included are Wall Street scandals involving New York Investment Houses and notable individuals. These instances coupled with an already strained and chaotic insurance marketplace has resulted in dramatic increases in the cost of Director's and Officer's Liability Insurance, as well as higher deductibles and limited coverage. Regardless, this temporary market condition does not alter the exposures to the Directors and Officers of privately held corporations. To the contrary, the public focus on the misconduct and malfeasance of Directors and Officers of large public corporations has a trickle down effect and can expose individual Directors and Officers of privately owned corporations.

The public will demand changes in the laws and the expansion of regulatory authority in an effort to protect the "Little Guy". This will have a "carry over" effect on every Director and Officer.whether at the helm of a public or a private entity.

For your own protection, peace of mind and financial security.it is recommended that you discuss this matter with your individual insurance professional. This should be done whether you are a Director or Officer of a publicly owned organization, private corporation or a non-profit corporation. And, finally, individuals and outside directors can enhance their protection with a "personal Director's Liability policy" to protect their own personal interest in the event the corporate Director's and Officer's policy is not adequate or available.

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W. Meade Collinsworth, CPCU, ARM, AIM, AAI, is President of Collinsworth Alter Nielson Fowler and Dowling, Inc., a Miami Lakes, Florida insurance agency specializing in insurance for architects, engineers, land surveyors and contractor construction related activities. Mr. Collinsworth is a regular contributor to the Guest Essay column of the a/e ProNet Website.

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NOTE: This article is intended for general discussion of the subject, and should not be mistaken for legal advice. Readers are cautioned to consult appropriate advisors for advice applicable to their individual circumstances.