When reviewing your corporate insurance policies, one of the worst possible mistakes is budgeting for employment practice insurance and general liability insurance and then overlooking directors and officers (D&O) insurance.
“Corporate managers need to understand that no matter the size of their company, they are not immune to litigation against directors and officers,” says Ron Hodges, partner and director of the Litigation Department at Shulman Hodges & Bastian LLP. “They have read a great deal about the Enrons and Tycos of the world, but smaller public [and private] companies in their own communities are just as vulnerable.”
Directors and officers insurance protects personal assets and/or company assets. It also provides access to valuable resources to help companies manage litigation.
Smart Business spoke with Hodges about how companies large and small can minimize their exposure to D&O lawsuits.
How can a company be damaged by a lawsuit against its directors or officers?
With or without insurance, a D&O claim against a company can be devastating on a number of fronts.
Financially, it can cripple a company. We have seen companies literally forced to close their doors or seek bankruptcy protection just by virtue of the professional fees associated with litigating a claim notwithstanding the fact that they might be in the right.
From a time standpoint, D&O claims can cripple a company because executives must occupy their time dealing with litigation matters when they could be more productive by spending time on the nature of their business.
Finally, any company facing D&O litigation is potentially susceptible to negative publicity. Mere rumors and allegations will have a negative effect on a business and on the reputation of the principals regardless of whether the allegations turn out, at trial, to be true.
A director’s and officer’s lawsuit is a taxing and a very significant event for a company, regardless of whether or not it has merit.
What kind of claims are the most common?
Many claims occur in the employment arena where directors and officers have not handled an employee dispute properly or they themselves were personally involved in the termination. Typical suits include wrongful termination, discrimination, harassment or misrepresentation of employee benefits.
But the most common claim is for a breach of fiduciary duty, most often in the instance of a transaction that personally benefits a director or officer to the detriment of the company or its other shareholders.
A third type of claim results from a company owing money to a vendor or customer, which tries to hold directors and officers personally responsible for all of the corporate debt and obligations.
Who most often brings legal action against directors and officers?
In our society, we tend to deflect responsibility for our own actions. If a customer knows there is risk involved in a certain business move, he or she still wants to blame others for losses and the directors and officers are there to blame.
Another scenario stems from a need to survive. Companies in dire financial straits may attempt to pursue the recovery of money by filing a lawsuit just to leverage a settlement during a negotiation.
Companies often face the daunting task of assessing the business realities a case presents. It is often less expensive to settle a meritless claim than pursue the defense through trial. That is unfortunate, but a reality nonetheless.
How much are premiums for directors and officers insurance?
Coverage should be commensurate with the growth of the particular business. And if a company is doing poorly, it may need less insurance.
There are two different types of insuring provisions. One protects corporate assets, the other protects the assets of the individual. Some companies only maintain the insurance that protects the assets of the company, because it has lesser premiums.
Other cost factors are how much insurance you are purchasing and how much the insurance company is willing to write for your particular company.
What else can guard against D&O lawsuits?
Astute corporate leaders should certainly consult with their professionals including their insurance brokers at least once a year. Encourage your outside professionals to interact with each other. When you have done that, you need to properly document that interaction. You need to show that you have exercised prudent judgment in your corporate decisions and that you have sought the advice of objective outside professionals regarding whether a given action is appropriate from a business and legal point of view.
Documentation acts as a safety net for officers and directors when they are scrutinized in litigation that sometimes has the unfortunate benefit of 20-20 hindsight.
RON HODGES is a named partner and the director of the Litigation Department at Shulman Hodges & Bastian LLP. Reach him at (949) 340-3400 or email@example.com.