As a director or officer of a company,
whether public or private, you may
be pulled into lawsuits alleging damages as a result of your, or your company’s, actions. These suits may allege
such things as discrimination, sexual
harassment or misstatement of the company’s finances. In situations such as
these, the best tool for defending yourself
is the broadest possible directors and
officers (D&O) liability insurance policy.
“All companies, whether public or private, should have directors and officers
liability insurance. This coverage is for
those very rare, but potentially very
expensive, situations that are not covered
by other types of insurance,” according to
Tim Folk, a producer at The Graham
Company.
Smart Business talked to Folk about
the protections provided by directors and
officers insurance.
What does D&O liability insurance provide?
In general, D&O liability policies provide coverage for claims alleging damages as a result of two major categories of
incidents: (1) acts, errors, omissions, mis-statements, misleading statements or
breach of duty in your capacity as a director or officer of the company, or (2) discrimination, sexual harassment, wrongful
termination and other employment-related situations. Both of these situations are
typically excluded by standard general
liability policies. D&O policies fill the
gaps left by the other insurance policies
you may have.
Claims alleging financial loss as a result
of an act, error or omission of a director
or officer typically occur when a public
company’s stock price suddenly drops as
a result of the action, or inaction, of company management. Recent cases, such as
those involving Enron and WorldCom,
are examples of this type of claim. Public
companies receive these claims far more
frequently than do private companies.
Claims alleging discrimination, sexual
harassment or wrongful termination happen frequently to both public and private
companies. Some D&O policies offer this coverage, others do not. Whether it’s part
of the D&O policy or not, employment
practices liability coverage is a good idea
for all companies to consider.
What should a company look for in its D&O
coverage?
Two of the biggest things to look for are
severability and the right to settle claims.
Most policies include severability provisions, which stipulate what will happen
to the coverage if information in the policy application turns out to be false or misleading. Some policies will say that if the
person signing the application made false
or misleading statements, then coverage
is essentially voided for all directors and
officers, even if they didn’t know that the
person signing the application provided
false information.
A good broker can negotiate something
called full severability of the application,
which means that in the event of false or
misleading statements in the application,
coverage would only be void for the individual who made the false or misleading
statements. Full severability of the personal profit, fraud and criminal acts
exclusions may also be available. This
means that if a director or officer commits fraud and is convicted, then coverage would be void only for the person
who committed the fraud but not for the
rest of the directors and officers.
The second thing to look out for is who
has the right to settle claims. Many policies specifically state that the carrier has
the sole right to settle a claim. This means
that you will not be able to stop or influence a settlement if the carrier is ready to
make payment. You may not want to be in
this situation if you feel that a claim
should not be settled because it will send
the wrong message or hurt your company’s reputation, for example.
Your broker may be able to change this
provision so that the insurance company
is required to receive your approval prior
to making any settlement offers. This
approach can have a potential downside,
though. In exchange for giving up total
settlement control, the carrier may insert
a hammer clause, which makes you liable
for any increase in the ultimate settlement amount because you withheld your
consent to settle.
What are some best practices to avoid litigation?
For a public company, probably the
most important thing is to have procedures that eliminate insider trading of
company stock at suspicious times and in
suspicious amounts and to have disciplined disclosure practices. There should
be written procedures that include trading windows and blackout times, naming
of a trading compliance officer and procedures for special blackout period
implementation for sensitive times, such
as during mergers or divestiture activity
or an earnings restatement.
For a private company, the best way to
avoid employment-related litigation is to
provide proper training and education to
all of your employees, especially those
that manage others.
TIM FOLK is a producer with The Graham Company. Reach him
at (215) 701-5231 or [email protected].
