D&O Coverage Considerations When Your Company is Private or Non-Profit
Many private companies and non-profit organizations believe that there is no need to purchase directors’ and officers’ (D&O) liability insurance, due in part to the belief that the only significant source of liability to a director or officer is from a disgruntled shareholder of a company. However, lawsuits filed by shareholders represent only a portion of all reported lawsuits brought against directors and officers. Many other types of D&O lawsuits are brought by other parties, including employees, customers, creditors, vendors, competitors, and regulators — exposures that exist regardless of the number of shareholders or whether the company is private, non-profit, or public.
There are many exposures that present potential liabilities to the personal assets of directors and officers of privately-held and non-profit companies, and this extends to the personal assets of their spouses and estates.
Legal Standards of Conduct for Directors and Officers of Privately Held Companies and Non-Profit Organizations
The applicable legal standards of conduct for directors and officers of privately held and non-profit companies are identical to those of publicly held corporations. All directors and officers are subject to three basic duties in performing their responsibilities:
Purported breaches of these duties can lead to claims against directors or officers of privately held companies and non-profit organizations.
Though a company’s by-laws usually provide some type of indemnification to its directors and officers, there are many situations where corporations are unable (or unwilling) to provide such indemnification. Examples include:
- Inability to Indemnify: financial insolvency or insufficient cash flow.
- Unwillingness to indemnify: new management team/corporate takeover.
- Derivative claim: Claim is brought on behalf of the corporation and, in certain jurisdictions, indemnification is not permitted.
- Interpretation of “good faith:” In many jurisdictions a corporation is not obligated to indemnify its directors and officers if the director or officer did not act in “good faith.”
- Agreed not to indemnify: Bylaws of some organizations preclude indemnification for certain acts. Commonly, alleged fraud or intentional misconduct may not be acts for which a director or officer is indemnified. In the above scenarios, the only buffer between a claim and an individual’s personal assets is D&O insurance.
Private Company Exposures:
Claims by employees: Claims alleging harassment, discrimination, and wrongful termination against the company itself and the directors and officers. A properly designed private or non-profit D&O insurance program can respond to these claims (commonly known as employment practices liability – EPL) against the entity and individual insureds.
Claims by customers, clients, and consumer groups: Common allegations include harassment, discrimination, violation of civil rights, contract disputes, misleading statements and false advertising. In addition, clients can also become claimants in the event of financial impairment of the company.
Claims by competitors, suppliers, and other contractors: Common allegations include anti-trust violations, unfair competition resulting in lost business by the competitor, and infringement of patent, trademarks, and trade secrets.
Claims by other third parties: Claims vary from those relating to environmental contamination to employee health and safety. Additionally, privately held and non-profit corporations can face investigations and claims by certain regulatory agencies, including the SEC and DOJ, with respect to suspected or actual wrongdoing.
Claims by shareholders/lenders: Suits brought by private shareholders, bondholders, or other investors or lenders. Claims can include alleged misrepresentation and inadequate or inaccurate disclosure in financial reporting of private placement materials. Due to lack of availability of a private company’s financial data, these stakeholders rely heavily on the materials and statements made by private companies. Other examples of shareholder claims affecting private companies include:
- Breaches of the duty of care with respect to how the directors and officers handle the sale of a corporation or how they missed a great business opportunity for the corporation.
- Breaches of the duty of loyalty with respect to deals the corporation enters into with companies owned in whole or in part by one or more of the directors and/or officers.
Mergers and acquisitions (M&As): A private or non-profit company can enter into an M&A as the buyer or seller. D&O insurance can help protect against potential claims, including:
- Disgruntled shareholder suits.
- Alleged financial misstatements or misleading statements about the company’s revenue sources/market share.
- Failure to perform appropriate due diligence when making an acquisition.
- Bankruptcy resulting from a failed transaction.
- Claims from past creditors and/or vendors of the acquired company.
Succession planning and corporate governance: Many private companies are run by, or have founding members (and sometimes their families) closely involved, in the day-to-day operations through their ownership stakes in the company which results in:
- Proxy disputes when founders are pushed out of their leadership roles.
- Legal disputes amongst family members when they are a part of an ownership trust relative to the operation of a company or potential transactions.
- Poor succession planning can lead to leadership vacuums and/or disputes in the event of a sudden change in leadership due to illness or death.
Why Do Private and Non-Profit Companies Need D&O Insurance?
- To protect the personal assets of directors and officers and those of their spouses and estates.
- To protect the income statement and balance sheet of the company.
- To attract and retain qualified outside directors.
- To establish a relationship with an insurer before a potential initial public offering (IPO).
- To avoid diverting management attention to protracted and costly litigation.
What Do Private and Non-Profit Company D&O Policies Cover?
Private company D&O policies afford coverage to the board of directors, executive officers and employees of a corporation for claims made against them in their capacities as such. These policies further afford coverage to the corporate entity for purported breach of duty, negligence, error, misstatement, misleading statement, act or omission in the performance of their duties to manage the company. Often, private and non-profit company D&O policies include broad coverage for claims involving violations of employment practices laws, thus sometimes minimizing the need for a separate stand-alone employment practices liability policy. Program limits and coverage provisions should be assessed on an annual basis.