What does directors & officers insurance cover and how do you know if you need it?
First off, directors and officers insurance is specialized coverage designed to specifically protect the management of a company. The insurance covers litigation expenses and damages should a director or officer be sued directly by an outside party. Such third parties may include investors, customers, employees or other interests. In the event of such litigation, the personal assets of those directors and officers may be at risk. Directors and Officers insurance is the type of coverage that will indemnify a director or officer for legal defense costs and damages. This type of coverage would also indemnify a company in instances where the company covers such costs for its directors or officers.
So what are some instances in which a director or officer could face this kind of situation? This is an area that has been getting more and more attention due to the frequency with which such suits are being brought. Claims made against a companies management can cover a lot of ground including instances such as
- Breach of Fiduciary Duty
- Claims of illegal business practices
- Regulatory violations
- Shareholder lawsuit
There’s more than this to the list but you get the idea that there is quite a bit of risk that this type of insurance will cover. Essentially claims aimed at the leadership of a company involving management decisions or company policy can fall into these category.
Hopefully this give a bit of insight as to what the insurance is designed cover. As far as knowing if you need it, if you are a publicly traded company, you do need it and you already have it (at least you better). More likely if you are asking this question it is because your company is a privately owned and you are debating if you need it. From my experience the answer comes down to three rationales.
A prerequisite to a funding round
One point at which it makes sense to insure your directors is if getting a pile of money depends on it. In many cases, venture capital or private equity firms will make directors & officers insurance a contingency to closing a round of funding for a company. The amount of coverage will be set by the funding entity but more often than not this figure will start at $1mm coverage. As the size of a funding round increases, the amount of coverage will go up.
You are trying to land a board member and they require it
I’ve had clients out in Silicon Valley try to bring experienced people in to become part of a board of directors. The people that were targets of these companies were experienced old hands in the tech and startup space, so one of the first requirements these folks had was making sure that D&O was in place. If you are trying to put a board in place made up of experienced industry veterans, be prepared to have Directors and Officers coverage become part of the conversation.
A third rationale is a little more of a judgment call on the timing, but if you yourself are an officer and are asking this question, you will want to consider it when you feel it is time to……
CYA-Cover Your Ass
As soon as there are directors and officers acting in a management capacity, there is a need for this type of coverage. Most bootstrapping startups will put it off until there is a trigger and that’s understandable but if the company has some traction and is moving along well enough where the resources are there, get this in place.
If this is something your company has considered implementing and could use some more guidance feel free to reach out with a call or an e-mail. I’ll be happy to act as a resource.
Business Insurance & Benefits Services of MA