What does directors & officers insurance cover and how do you know if you need it? Directors and Officers insurance is designed to protect the directors and officers of a company from litigation expenses and damages where such people are directly sued by an outside party. Such third parties may include investors, customers, employees or other interests. The private assets of such directors and officers may be at risk in such litigation. The directors and officers insurance is a coverage that will indemnify a company director or officer for legal defense and damages or indemnify a company in instances where it will indemnify their director or officer in question.
So what are the instances in which a director or officer could face such a situation? This is an area that has been getting more and more attention due to the frequency with which such suit are being brought. Claims against D’s and O’s 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 a lot of ground. Essentially, a type of claim that is aimed at the leadership of a company regarding leadership decisions and policy can fall into this category of claim.
As far as knowing if you need it, if you are a publicly traded company, yes you do and you already have it (at least you better). More likely if you are asking this question it is because your company is a private one 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, VC or private equity firms will make this a contingency to closing a round of funding for a company. The amount of coverage will be set by the entity but more often than not it is a stock $1mm coverage amount. EPLI may also be a component of this prerequisite and would be a separate line item in a comprehensive management liability policy, just be aware.
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.