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.
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:
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:
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:
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:
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.
Foundations: Corporate governance for foundations is a frequent area of criticism especially if there is the perception of poor succession planning and excessive executive pay. There have also been claims regarding perceived inefficiencies in the use of funds raised that are actually used towards the stated mission.
Higher Education: Higher education institutions face a number challenges including distressed not-for-profit higher education. Moody’s reported in 2015 that 1 in 10 colleges suffer from acute financial distress due to falling revenues and weak operating performance, which is magnified in graduate programs where law schools are seeing historic declines in enrollment. There are also a number of higher education institutions with hospitals that carry the same exposures as a standalone health system, such as anti-trust, D&O and EPL claims brought by doctors, to name a few.
Private Companies in Financial Distress: Private companies in financial distress can have negative repercussions just as it would in the public company space, such as claims of misrepresentation or breach of fiduciary duty brought by secured creditors (lenders, banks, financers, board represented equity holders) and unsecured creditors (vendors, equity holders with no board representation) against the company, its board and officers.