Protecting your own Featured

12:51pm EDT May 17, 2006
In light of the recent wave of corporate scandals, directors and officers have come under increased scrutiny. Meanwhile, increased corporate governance, in the form of the Sarbanes-Oxley Act, has had a major impact on their liability. That’s where directors’ and officers’ liability insurance comes into play.

This type of insurance is a wise investment for businesses of all sizes, says Marc L. Seror, vice president of Sander A. Kessler & Associates Inc. “It doesn’t just apply to public companies, but also for many privately-held companies, as well as nonprofits.”

Smart Business spoke with Seror about what types of claims can be made against directors and officers, how companies can benefit from having liability insurance and what types of coverage should be included when purchasing a policy.

What is directors’ and officers’ liability insurance?
It’s insurance to protect the individuals who serve as directors and officers of a company. The duties of a director and officer really include the duty of loyalty, the duty of care and the duty of obedience. A breach of those duties is what leads to a variety of claims. Many times, this type of insurance can also protect the company itself from a variety of lawsuits.

Who can make a claim against a director or an officer?
Most people think only stockholders can file a claim, but actually, any stakeholder can do so. A stakeholder can be a customer, competitor, vendor, fellow board member and even employee. The Tillinghast 2003 Directors’ and Officers’ Liability Survey states that half of all claims made against directors and officers are made by shareholders while a third of all claims are made by employees. Directors and officers of companies experiencing mergers and acquisitions or divestiture activities are more exposed to claim potential.

What kinds of claims are covered by directors’ and officers’ liability insurance?
The claims can include employee discrimination, unfair employment practices, wrongful termination, disposal of corporate assets without regard to the firm’s ability to pay for or secure the company’s debt, violation of antitrust laws, unfair competition and even improper loans made to directors and officers.

How can a company benefit from having this type of insurance?
It gives an organization the ability to attract a director or officer to serve on their board. Without directors’ and officers’ liability insurance, no one in their right mind would accept a position because their personal assets are at risk for the decisions they make as board members. With the new Sarbanes-Oxley Act of 2002, the cost to the individual may actually be higher.

How has the Sarbanes-Oxley Act affected the liabilities that company leaders are faced with?
The Sarbanes-Oxley Act is the legislative response to the financial collapse of Enron, WorldCom and Global Crossing. This [federal] act targets corporate disclosures and it establishes criminal liability for their misrepresentations. The goal is to eliminate the expense abuses, off-balance sheet investing and other corporate misdeeds. It does this by requiring companies to file reports with the SEC which include reports on corporate governance, financial disclosure, auditor independence and even corporate fraud.

Although the law only applies to public companies, some recent judicial rulings suggest the trend toward greater accountability will apply to privately-held companies as well. For example, a recent Delaware court ruling indicated that independent directors could be held liable for deliberate indifference as well as active negligence.

What basic coverage should be included?
When someone is looking to buy directors’ and officers’ liability insurance, the first thing they should look for is coverage that is ‘pay-on-behalf-of’ rather than coverage that indemnifies. Obviously, one would rather have an insurance company pay on their behalf rather than reimburse them for expenses or claims.

A second item is the limit should be sufficient to protect the company’s assets. There should be full coverage for prior acts, and it should go as far back in time as possible. There should be a broad definition of claim, and they should include coverage for the entity whenever it is available. Punitive damages should be included where they are insurable, though not all states allow it. Also, they should have the most favorable venue wording.

What factors are considered when setting a premium for directors’ and officers’ liability insurance?
The premium is a function of several underwriting factors that include the assets of the company, the company’s prior claim experience, any recent activity like mergers and acquisitions, reorganizations or layoffs. Also, the limit of coverage that is selected and the financial strength of the company are factors that are taken into consideration.

MARC L. SEROR is vice president of Sander A. Kessler & Associates Inc. Reach him at (310) 309-2269 or marc@sanderkessler.com.