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Navigating private companies’ D&O risks and coverage opportunities

A D&O liability policy is crucial for protecting the personal assets of a company's board and executives. Learn more about how to navigate these risks.

Understanding the coverage your company needs

A directors and officers liability (D&O) policy is intended, in part, to protect the personal assets of a public or private company’s board of directors and executive officers, subject to its terms and conditions. However, purchasing a D&O policy is a fundamentally different decision for a private company than it is for a public company, in large part because the main drivers of claims incurred on private company D&O policies have not historically been well understood.

One important distinction is that the scope of entity coverage under a private company D&O policy is generally much broader than what is available for public companies. Because of this breadth of coverage, it is notable that a greater percentage of actual payments made under private company D&O policies result from coverage for the corporate entity, which tend to be considerably more complex than for public companies.

Subject to the specific facts of a claim and the terms of the policy, directors and officers insurance covers directors and officers of companies who are sued in their managerial capacity. It is typically thought of as essential for public companies, as suits against their directors and officers often attract significant attention and create internal challenges for boards of directors. While the different public disclosures required, and their shareholder bases, mean that private company directors and officers face less potential exposure from securities claims than public companies, these exposures are still meaningful.

Further, private companies are exposed to a much broader range of litigation brought against them, and, unlike public companies, typically have the ability to purchase D&O insurance coverage for these claims.

Coverage for a wide range of risks

Public company D&O policies typically only cover the entity for a single named peril — securities claims. In contrast, private company D&O policies typically are true all-risk policies, providing broad entity coverage for the company. The scope of that entity coverage is only pared back by the exclusions in the policy form.

The broad entity coverage available for private companies reflects the wide range of risks that a private company is exposed to. While public company D&O policies are typically only triggered by shareholder claims, private company D&O policies typically can cover claims brought by customers, competitors, federal regulatory agencies, state attorneys general, and others, in addition to shareholders.

Considering this wide risk landscape, it is important for private company D&O insurance buyers to be knowledgeable about the breadth of coverage available to them and how it applies to their specific risk profile. It is also critical for buyers to understand the severity of the loss drivers, allowing them to purchase appropriate limits to protect their organization and its directors and officers.

Key loss drivers

The largest loss drivers of claims made against private D&O policies arise from:

Antitrust
Bankruptcy
Customer or competitor complaints
Regulatory and government enforcement actions
Shareholder/breach of fiduciary duty
Breach of contract claims

Claims containing these allegations are the leading loss drivers from both a frequency and severity perspective. The highest severity claims typically relate to antitrust and bankruptcy allegations, often leading D&O insurance providers to either sub-limit or exclude antitrust coverage, or to decline coverage to companies where there are insolvency concerns.

Protecting your company as risks evolve

As companies grow in size, the risks associated with these claim drivers become increasingly pronounced, with the risk profile of larger private companies often resembling that of a publicly traded company. The likelihood of a claim also increases.

The amplified risks underscore the importance for private companies to continuously re-evaluate and adjust their D&O program, including limits purchased, to reflect the changing risk landscape.

Further, considering the broad nature of claims submitted against private company D&O policies, it is important for companies to understand the coverage and exclusions in their policy form as well as the notice and reporting obligations. It is not unusual for private companies to overlook non-securities claims and fail to report covered claims on a timely basis, causing potential future problems.

Private companies often face allegations of anti-competitive behavior or violations of antitrust laws, which can lead to regulators bringing investigations and/or civil or criminal actions against the company and its directors and officers. These types of allegations can also lead to claims or lawsuits from consumers, sometimes in a class-action format. Claims for antitrust violations often include accusations of price fixing and collusion. While US regulators have certainly been prominent leaders in this area, similar claims have been seen in other jurisdictions. If there is the potential for antitrust exposure, consideration should be given to whether, and to what extent, a company’s D&O policy covers antitrust allegations.

With the rise in anti-competitive allegations and investigations by regulators, many insurers have tried to exclude coverage for antitrust claims altogether or sublimit their exposure. Coverage should be expanded to the extent possible, and the policy’s terms should be negotiated in order to provide coverage for non-indemnifiable antitrust claims where directors and officers are named.

Healthcare, education, and technology companies are at a heightened risk of antitrust claims, which leads to more scrutiny from underwriters that may seek to sub-limit or exclude coverage.

One of the largest drivers of private company D&O claims are bankruptcy filings or insolvency events. Issues leading to bankruptcy or insolvency — including poor capital management, special dividends extracted from a company by a private equity sponsor, creditor classes at odds with one another, and other highly litigious circumstances — can often serve as a roadmap for a D&O claim. A D&O claim against a bankrupt or insolvent company is of particular concern since the company will be unable to indemnify its directors and officers, putting their personal assets in danger if they do not have adequate D&O coverage. In addition, many private companies do not purchase dedicated Side A limits for individuals, further exposing the personal assets of their directors and officers.

It is important to note that many potential parties may seek to recover their losses against the insolvent company and its directors and officers during a bankruptcy or restructuring. These include customers, competitors, and secured and unsecured creditors. The latter are of particular risk to a company because they are generally only likely to recover a small portion of their losses and are typically more incentivized to contest even small amounts.

A final consideration for private companies’ directors and officers is that the broad entity coverage in a private company insurance form may potentially work against them in a bankruptcy scenario. This is mainly because the broader coverage for the company may dilute the coverage left for individuals. It is important for a D&O policy to include a priority of payments provision specifying that the coverage should first respond on behalf of individuals. However, even that protection does not provide the certainty of dedicated Side A limits specifically purchased for the individual insureds.

In addition to securities class actions, private company D&O policies provide entity coverage for consumer class actions. Consumer class actions may arise from a wide range of potential allegations, including deceptive labeling, false advertising, food contamination, product defects, privacy violations, and any other potential wrongful acts that could impact a class of consumers. When lawsuits alleging such wrongdoing are brought in the form of a class action, potential damages are typically higher and there are significant reputational concerns. Private company D&O policies may contain exclusions that impact coverage for those allegations, so it is imperative for buyers to structure their policies to cover the various forms of consumer class actions.

Private companies are at an increased risk of claims alleging anti-competitive behavior brought by government agencies, most often the Department of Justice (DOJ) and the Federal Trade Commission (FTC). In addition, the Securities Exchange Commission (SEC) may bring enforcement actions against private companies while the US Food and Drug Administration (FDA) may bring claims alleging false advertising. Companies are also subject to qui-tam or whistleblower claims filed by one of their employees or a competitor. Further, private companies need to be concerned about state attorneys general, who are also empowered to bring regulatory actions against a company.

Like public companies, private companies could also be targets in securities claims brought by their shareholders or investors alleging a breach of fiduciary duty. Examples include cases brought against “unicorns”, often involving technology or life sciences startup companies, that are active in capital markets, rely on major outside investors before going public, and are already considering a transaction — whether a merger or acquisition, or going public — as part of their growth. The managerial capacities of private company directors and officers put them at risk of a range of legal actions, including suits by creditors, business competitors, and customers, as well as actions brought by regulatory agencies. In each case, the suit may name the private company and its individual directors and officers as defendants.

However, for the risk of shareholder lawsuits is not just limited to unicorns or high-growth industries; a wide range of ownership structures, such as companies owned by private equity firms, employee stock ownership plans (ESOPs), family-controlled businesses, and other private companies are also frequent targets of shareholder or investor claims.

Common D&O securities claims allegations include:

Claims relating to negligent management: This is a broad type of claim and includes negligent actions or inaction by the board in overseeing the company. It doesn’t matter if a company is privately held or publicly traded — if directors and officers have been negligent in exercising their duty of care to manage in the best interests of a company, they are exposed to both direct and derivative lawsuits alleging negligent behavior.
Claims relating to conflicts of interest: Depending on the ownership structure of a private company, private companies are exposed to litigation alleging that one class of investors has committed acts that are detrimental to other classes. Examples include when a private equity firm with a controlling interest in a private company pays itself a special dividend that dilutes the value of the company for other investors, or when directors or officers of an ESOP owned company sell shares before a valuation report is released that discloses a lower valuation for the company’s shares than what was previously reported.
Claims based on inadequate disclosures in financial reports or statements, or misleading statements to investors: Claims relating to purported efforts to misrepresent the value of the company to potential investors are often brought against private companies and their directors and officers. For private companies considering a public offering (whether debt or equity), D&O coverage should, if possible, address pre-initial public offering (IPO) preparations exposures. While many companies will move to public company D&O policies once they become public, coverage for pre-IPO preparation can often bridge the gap between acts involved in looking to go public and actually going public.
Breach of contract claims: Such claims derive from the terms of an agreement between the company and its investors or other third parties, including explicit misrepresentations in the contract. These can include other violations of the contract, such as the company improperly facilitating dilutive transactions or failing to provide adequate disclosures. It is important that private companies assess their risk profiles; where there is a risk of contractual liability exposure, then the company should seek a D&O policy with limited contractual liability exclusionary language. Some private company policies specifically exclude coverage for breach of contract claims brought solely against the company. At a minimum, private companies should try to negotiate the language of the policy so that it provides coverage for directors and officers if directly faced with a claim for contractual liability. This can be done in a number of ways; for example, the policy can allow for an allocation of costs, judgments, and settlements as covered losses if claims are also brought against individuals.

Private companies should be aware of these litigation risks and should consider obtaining a D&O policy with language drafted in a way that is favorable and tailored to the specific needs of the company and its directors and officers. For example, exclusionary language should, if possible, be limited to excluding coverage for a direct loss caused by a particular factor as opposed to excluding coverage for a broader claim, such as a resulting management claim.

D&O coverage considerations for private companies

Private D&O policies typically are true “all risk” insurance policies that provide entity coverage for the company unless the insurance policy contains an exclusion to pare back that coverage. It is important for private companies to closely evaluate the scope of any exclusions on their policies, allowing them to understand the limitations of coverage. This is especially critical considering that exclusions for all of the loss drivers described above can be added to a private company’s D&O policy. Key exclusions include:

Breach of contract
Antitrust
Professional services
False advertising
Governmental funding
Cyber

Virtually all private company D&O policies contain some of these exclusions, which vary in scope. Some of these exclusions may be limited by including carve backs for defense costs, or sub-limits of liability that offer coverage that is less than the full limit of liability of the policy. Structuring policies to include coverage for a wide range of potential perils and limiting exclusions is essential for private companies.

Other benefits of D&O coverage for private companies

There are a number of factors that can make privately held companies vulnerable to D&O claims. For example:

Directors and officers of privately held companies are more likely to be closely involved with all aspects of the business and thus named individually in any kind of litigation.
Private companies and smaller companies in general often do not have the same access to outside resources to prepare for or defend these types of actions. Therefore, lacking an insurance policy to protect directors and officers could be catastrophic.
Many private companies consider going public at some time. D&O insurance can help with an IPO and any related potential liability. In addition, establishing a relationship with insurers before going public helps present a more seamless transition to a public company D&O policy.

The need for D&O insurance is not limited to larger private companies and those potentially going public. Private companies should consult insurance advisors to help understand the potential risks they face and how a D&O insurance program can protect directors and officers in an increasingly evolving risk environment.

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Navigating private companies’ D&O risks and coverage opportunities