Protect yourself Featured

7:00pm EDT January 26, 2010

Most executives consider directors and officers liability insurance a necessity for public companies, but privately held companies that overlook this coverage may not realize they are leaving themselves vulnerable. Philip K. Glick, senior vice president with ECBM Insurance Brokers and Consultants, says that a majority of private companies don’t think they need D&O coverage and are therefore reluctant to purchase it.

“They don’t think they need it because they are not worried about shareholder lawsuits,” Glick says.

However, this coverage can benefit not only directors and officers of public companies but those at private companies, as well.

Smart Business spoke with Glick about how D&O insurance can help protect private companies and how to avoid common coverage gaps.

Why do directors and officers of private companies need D&O insurance?

If you’re a private company and don’t have public shareholders, you can still benefit from D&O liability insurance. Only about 40 percent of claims covered by D&O policies are related to shareholder lawsuits against public companies; 60 percent are from other parties.

You could be sued by a customer, a vendor, a banker or other creditor, competitors, government agencies, or regulators. Those lawsuits comprise the 60 percent of claims not brought by shareholders and can be covered by a D&O policy. That’s why the coverage is critical for private companies and nonprofits.

What exposures can D&O insurance protect against?

Standard D&O policies cover lawsuits. If a competitor sues you for tortious interference of contract or unfair competition, D&O covers that. This is a ‘you stole my customer’ situation. I had a deal with someone, but you got a copy of my proposal, bid against me and took the client. Or if a customer sues for misrepresentation of services, D&O can cover that. If a lender sues, saying you misrepresented financial statements and it lent you money it shouldn’t have, D&O can also cover that. It has a much broader application than people think.

What is not covered by a standard D&O policy?

Mediation and arbitration actions are normally not automatically covered. You need to add those. Also, if someone says you’ve committed a criminal act or they say you’re infringing on their business and demand an injunction, the standard policy does not cover that. But you can add coverage for defense fees arising from the filing of criminal allegations and demands for injunctive and other nonmonetary relief. You can also buy coverage for regulatory and administrative acts. For example, no one has sued you, but an administrative agency is investigating you; insurance will cover the defense costs of the investigation.

What other hidden coverage gaps does a business leader need to be aware of?

Make sure you have coverage for all subsidiaries or affiliated companies. Most D&O coverage applies automatically to majority-owned affiliates; it does not cover minority-owned companies. If you have a 40 percent interest in a company and are sued through a D&O claim, if you didn’t schedule that on your policy, it’s not covered. Next is legal defense counsel. Normally, counsel is chosen by the insurance company. But it’s important that you have the right to choose your lawyer.

How can you keep an insurance company from canceling your policy?

Most D&O insurance policies can be cancelled by the insurance company with 30 to 60 days’ notice for any reason. Make sure the insurance company can’t cancel it once you’ve paid the premium. If a lawsuit is filed, the insurance company may have to defend it, but then it cancels your policy, eliminating coverage for any additional potential claims. It seems unfair, but it can do it.

You’re buying this policy to be an insurance bulletproof vest to protect you against all these companies that want to do you financial harm. But the insurance company can cancel the policy on 30 days’ notice. When is that important? When somebody just sued you and you’re worried about another claim. Many insurers will agree upfront not to cancel your policy during the current policy term other than if you fail to pay the full annual premium.

How can you prevent an insurance company from denying coverage for a claim?

Make sure severability is included in the application for your policy and for the exclusions that are part of your policy. When you apply for a policy, you provide financial information and statements about your knowledge of potential claims, or errors that can result in claims. If you misrepresent information in the application and a claim results from that, insurance companies can try to deny a related claim or rescind the policy in its entirety.

Severability means they will only rescind the policy or otherwise deny coverage for the individual who misrepresented information. Instead of tearing up the application, they’ll only deny coverage to those individuals who provided false information. Exclusions typically apply so the insurance company won’t cover claims based upon deliberate wrongdoing, fraud or other criminal acts. The policy may still be in effect, but that particular claim that was due to alleged fraudulent or criminal conduct will not be covered. Severability of exclusions means that an exclusion will only apply to the individuals who did those bad things; the innocent party will still be covered.

Also, make sure the policy covers you until final adjudication. If you’re accused of criminal acts, that doesn’t mean you did it — final adjudication wording means the policy will defend you until a court convicts you after all appeals have been completed.

Making the recommended changes in the application and policy language will assure protection remains for the good guys.

Philip K. Glick is senior vice president with ECBM Insurance Brokers and Consultants. Reach him at (610) 668-7100 x1310 or pglick@ecbm.com.