Rethink the need for D&O

For many private companies and nonprofits the cost of defending and settling an uninsured lawsuit could significantly impair or destroy the entity itself. This isn’t news. But spending a little more premium to package directors and officers liability (D&O) insurance onto your employment practices liability coverage could turn out to be one the most important assets for your organization.

Many people think that by being a smaller private, nonprofit and/or family run business, there is no potential for a D&O claim to occur. However, this unfortunately is not the case, says Dereck M. Malzi, area assistant vice president at Arthur J. Gallagher & Co. Regardless of the talent or strength of the organization or its management, even frivolous lawsuits can occur and the costs to defend them are on the rise. Even if your organization doesn’t have a large board, the coverage may kick in for any individual who is acting in the capacity of a director or officer.

“There’s a reason why some board members won’t agree to join your organization without D&O coverage,” Malzi says.

Smart Business spoke with Malzi about the importance of D&O and why spending a little more may be worth it to your organization.

What are some examples of claims scenarios where D&O could come into play?

Let’s say the vice president of a manufacturer determines that diversifying into a different product line presents tremendous sales potential for his company. Instead of presenting that opportunity to his employer, the VP shares his idea with his brother who forms a new company to produce that product. On behalf of the company, a shareholder might sue the VP, alleging that he wrongfully took advantage of an opportunity belonging to the corporation.

Another example would be if investors file a $5 million derivative lawsuit alleging breach of fiduciary duty. They might claim some of the officers had personal connections to a third-party contractor hired to re-tool the assembly line, so the contractor wasn’t hired to further the interests of the company. The suit could allege that other officers and directors breached their duty of care by undertaking the project without properly investigating the qualifications of the contractor.

Another scenario could involve misuse of funds. A state attorney general might sue a charitable foundation, alleging the trustees were excessively compensated and devoted insufficient time and resources to support the foundation’s intended purpose.

In all three of these examples, the settlements and attorney’s fees could run to several million dollars, which would put a significant strain on almost any organization.

How does fiduciary liability insurance differ from D&O?

D&O and fiduciary are typically bundled together, but D&O provides coverage for mismanagement, conflicts of interest, unwarranted compensation, failure to fulfill the organization’s mission, etc. Fiduciary liability insurance is specially designed to protect against claims alleging violations of the Employee Retirement Income Security Act of 1974.

What types of D&O insurance are available?

D&O insurance has three sides to it:

  • ■ Side A, ‘non-indemnified individuals’ — This provides coverage for individual directors and officers on claims that are not indemnified by the corporation, usually since it is either not legally permissible to indemnify or there are no funds to indemnify. Generally, Side A coverage has no deductible.
  • Side B, ‘indemnified individuals’ — This provides coverage reimbursement on claims against individuals who are indemnified by the corporation.
  • Side C, ‘entity coverage’ — This provides coverage to an organization for claims made against it, and separate and apart from claims made the directors and officers.

This information is the tip of the iceberg on the subject. Make sure you speak with a D&O insurance expert before you decide to pass on this protection for you and your company.

Insights Insurance/Risk Management is brought to you by Arthur J. Gallagher & Co.