Those of us immersed in the world of directors and officers could not imagine becoming involved in any sort of business organization without the protection and benefit of D&O insurance. Just the same, I have fairly regular conversations with officials and executives at closely held companies who see no need for the insurance, on their belief that without outside investors, their company faces no risk of incurring a D&O claim. However, long experience tells me that D&O insurance should be a part of every organization’s insurance program, regardless of its ownership.
As discussed in a July 17, 2017 memo written by Douglas Rappaport, Jacqueline Yecies, and Timothy Shepherd of the Akin Gump law firm and Sarah Katz Downey and Nirali Shah of Marsh and entitled “Why Private Companies Shouldn’t Overlook the Benefits of Directors and Officers Liability Insurance” (here), “it is critical for privately held organizations to closely consider the purchase of D&O insurance to protect both individual directors and officers as well as the company itself.”
D&O insurance does of course protecting company officials against litigation brought by investors. However, the list of potential claimants in a private company D&O claim is not limited just to shareholders or owners. As the memo’s authors note, “directors and officers of privately held companies are vulnerable to legal actions in their managerial capacities, including employment suits, suits by creditors, suits by business competitors and customers, and actions brought by regulatory agencies.” In any of these kinds of claims, the lawsuit may name both the private company and the individual directors and officers as defendants.
While many private company officials may feel that they face little chance of getting hit with a D&O claim, the fact is that private company D&O claims are frequent and expensive. As Chubb noted in its 2016 private company risk management survey report, more than a quarter of all companies reported having experienced a claim in the three preceding years. The average reported loss was $387,000. Among companies responding to the survey that do not buy D&O insurance, the average reported loss was almost $400,000.
The memo’s authors identify a number of types of typical or common D&O claims, including: claims relating to negligent management; claims based on inadequate disclosure in financial reports or statements; derivative actions alleging breaches of fiduciary duty; breach of contract claims; and antitrust claims and regulatory actions.
With respect to antitrust claims, the authors note that “many insurers have tried to exclude coverage for antitrust claims altogether or sublimit their exposure.” This is an important point, but the significance might not be apparent to many private company executives because they may not see how the antitrust exclusion could cut off coverage for many relatively common private company D&O claims.
In order to appreciate the extent of the coverage limitation that the antitrust exclusion represents, it is important to appreciate that the antitrust exclusion precludes coverage for a lot more than just antitrust claims. As discussed at length here, the exclusion may be referred to simply as the antitrust exclusion, but it also precludes coverage for restraint of trade, unfair or deceptive trade practices, and unfair competition. These kinds of allegations are very common in private company D&O claims, and so the inclusion of an antitrust exclusion in a private company D&O insurance policy could represent a very significant narrowing of coverage. The significance of the proposed policy terms related to the antitrust exclusion is just one of many key features that must be considered when selecting and obtaining D&O insurance coverage.
For private company officials skeptical of their company’s need for D&O insurance should appreciate that in addition to their company’s exposure to risks of this magnitude, the officials themselves are vulnerable to claims as well. As the memo’s authors note, directors and officers of privately held companies are more likely to be closely involved with all aspects of the company’s business and thus likelier to be named individually in any kind of litigation. This concern could be particularly apparent in the bankruptcy context, where creditors and others may seek to impose liability on the company’s executives, at the very time when the company itself is unable to indemnify them and to help with their legal expenses. In these circumstances, D&O insurance can represent the individuals’ last line of defense.
The need for D&O insurance, according to the authors’ memo, “is not limited to larger private companies and those potentially going public.” Fortunately for prospective D&O insurance buyers, private company D&O insurance policies available in the current marketplace provide broad coverage for a wide variety of claims at a relatively low cost.
There is an important difference between the coverage available in a public company D&O insurance policy and the coverage available in a private company D&O insurance policy. The coverage available for the insured organization in a private company D&O insurance policy is materially broader. In a public company D&O insurance policy, the entity or organization coverage generally is limited to securities claims. In private company D&O insurance policies, the entity or organization coverage contains no such limitations, meaning that private company D&O insurance policies provide broad balance sheet protection for insured private companies.
Private company D&O insurance policies also provide protection not just in the event of a lawsuit, but in a wide variety of other circumstances as well. The policy definition of the term “Claim” identifying the circumstances that trigger cover is much broader than just a lawsuit; it also typically involves “a written demand for monetary, nonmonetary or injunctive relief” as well as “a civil, criminal, administrative, regulatory or arbitration proceeding for monetary, nonmonetary, or injunctive relief.” In other words, a D&O insurance policy can help to provide protection in a broad variety of circumstances of the kind in which private companies frequently become involved, and not just in the event of a lawsuit.
Because the entity coverage afforded in a private company D&O insurance policy is, as noted above, broader than the entity coverage in a public company D&O insurance policy, private company policies typically include exclusions not found in public company D&O insurance policies. The antitrust exclusion mentioned above is an example of this type of exclusion found in many private company D&O insurance policies but not typically found in public company D&O insurance policies. Other common entity exclusions that may be found on private company policies include intellectual property exclusion; professional services exclusion; and contractual liability exclusion.
These kinds of exclusions potentially could significantly affect the availability of coverage in the event of a claim. It is important to note that in many instances many carriers will upon request significantly narrow or even remove some of these kinds of exclusion. For example, many carriers will on request remove the antitrust exclusion, at least for certain kinds of companies in certain circumstances. When I am asked to review companies’ D&O insurance policies, I am often surprised to see how frequently the wording of the various entity exclusions has not been addressed. Of course, it may well be in any specific situation that the carrier was asked but refused to modify the exclusions. But because the exclusions are so often modified, the absence of modifications could mean that the agent who placed the policy failed to request the modifications.
The bottom line is that the risk-management program of every well-advised company, whether public or private, should include a D&O insurance policy. The concerns noted above about the entity exclusions found in the private company D&O insurance policy underscore how important it is even for smaller private organizations to enlist the assistance of an insurance adviser that is knowledgeable about the risk exposures that the company and its officials face as well as about the various alternatives available in the D&O insurance marketplace. As the memo’s authors put it, “private companies should consult insurance advisers to help understand the important risks they face and how a D&O insurance program can protect directors and officers in an increasingly evolving risk environment.”
Readers interested in knowing more about D&O insurance may want to refer to my series of articles entitled “The Nuts and Bolts of D&O Insurance,” which can be found here.