D&O liability insurance Featured

7:00pm EDT November 25, 2007

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 tfolk@grahamco.com.