With all the excitement that comes with launching a new business, it’s easy to overlook the need for insurance. However, obtaining the right coverage is a crucial part of the process. One important type of insurance to consider is directors and officers (D&O) liability coverage.
You might be wondering, “Aren’t we too small for D&O coverage?” or “Isn’t that only for publicly traded companies?” Perhaps you’ve even assumed that general liability or umbrella insurance would protect your leadership team. These are widespread misunderstandings that could leave your business exposed if a claim is ever brought against your directors or officers.
D&O Coverage Is Essential for Private Companies and Nonprofits Too
Plaintiffs’ attorneys frequently target not only large corporations but also small and mid-size businesses, as well as nonprofit organizations, in lawsuits involving directors and officers.
Private companies face distinct risks. Founders and CEOs often play a hands-on role in operations and may commit a significant portion of their personal wealth to the business.
D&O insurance can be intricate. Collaborating with your insurance agent allows you to develop a tailored coverage portfolio that safeguards both your company and its individual leaders.
What D&O Covers
Directors and Officers (D&O) insurance shields your organization’s leadership from personal financial liability in the event of lawsuits filed by investors, employees, vendors, competitors, customers, or other parties. It provides coverage for claims made against directors and officers during their tenure on the board or in executive positions within the organization.
There are several kinds of D&O coverage your insurance agent can present to you:
Side A provides coverage for directors and officers when the company is unable or unwilling to indemnify them, covering defense expenses, settlements, and judgments.
Side B reimburses the company for indemnification payments made to directors and officers, thereby protecting the company’s financial resources.
Side C, also known as “entity coverage,” insures the company itself when it, along with its directors and officers, is named as a co-defendant in a lawsuit.
Side A DIC, (Difference in Conditions) policies offer additional coverage beyond the primary D&O policy, filling gaps such as insurer insolvency, refusal to pay, or legal restrictions that prevent indemnification. These policies often provide broader coverage terms and dedicated limits for directors and officers.
D&O policies typically operate on a one-year term and cover “claims made” against your company’s directors and officers during that period. If you’re securing coverage for the first time, ensure there are no exclusions related to activities associated with the launch of your business. It’s also crucial to confirm that legal representation is included in the policy.
When a claim is filed against your company or its leadership, you may have the option to select your own legal counsel. However, many D&O policies designate specific attorneys or law firms specializing in such cases to handle the defense.
Types of Exposure
Directors and officers can face legal action for a variety of reasons. Common exposures include:
- Failure to comply with regulations or laws
- Failure to maintain a safe and secure workplace
- Poor management practices
- Human resources (HR) issues
- Cybersecurity breaches
- Bankruptcy- related claims
Certain exposures are excluded from D&O coverage. Typically, claims involving fraud, bodily injury, and property damage are not covered. These types of risks are generally addressed through other specialized insurance policies.
You may also require a separate Employment Practices Liability Insurance (EPLI) policy to protect your company, board members, and officers against employment-related claims-some of the most frequent lawsuits faced by organizations.
It’s advisable to review your Employment Practices Liability (EPL) and Directors & Officers (D&O) insurance needs with your agent whenever your company undergoes significant changes such as hiring new talent, securing financing, acquiring or merging with another business, investing in new equipment or operations, or opening a new location.
Standalone vs. Bundled
Public companies typically purchase standalone Directors and Officers (D&O) insurance policies. In contrast, private and not-for-profit organizations often opt for bundled management liability packages that combine D&O coverage with employment practices liability (EPL), fiduciary liability, and other related coverages.
Be mindful of your policy limits, as they determine the total amount available for claims against your company’s directors and officers. These limits are typically shared across all coverage sides—Side A (individual coverage), Side B (corporate reimbursement), and Side C (entity coverage). Consequently, claims under Side B and Side C can deplete the overall policy limits, potentially reducing the coverage available for individual directors and officers under Side A. To mitigate this risk, consider purchasing a standalone Side A Difference in Conditions (DIC) policy, which provides dedicated limits exclusively for individual directors and officers.
As a point of reference, D&O losses for private companies in the United States run about $400,000 on average.
Questions You Can Expect
To evaluate your risk, you will need to provide detailed information about your company, including the nature of your business, your customer base, and any past claims involving your company or its leadership.”
It will be beneficial if your organization has policies and procedures in place to protect against lawsuits. For instance, you should have:
- Written HR policies that prohibit discrimination and sexual harassment
- A policy regarding social media use within the workplace
- A business continuity plan
- A network security and privacy policy A corporate governance program
- Written procedures to manage fiduciary duties
- Clear guidelines for performance reviews and policies to address unacceptable performance
Create the Ultimate Program from the Beginning
One of the first questions a potential director or officer will ask is whether your company has a D&O policy. If they are at risk of personal liability, they may hesitate to join your firm or serve on your board. They want to safeguard their personal assets. Additionally, most venture capital and private equity firms are unlikely to invest in a company without D&O coverage, as they seek to protect their investments.
Securing a directors and officers liability insurance policy is a key investment in your company’s financial stability. It’s an essential component of your risk management strategy. From budgeting to risk mitigation, your insurance agent will customize your D&O policy to meet your unique needs, allowing your leaders to focus on steering your new venture toward success.