Directors and Officers Insurance

The corporation is the cornerstone of capitalism. By coordinating and combining the capital investment of many participants, issuing shares representing that investment, and allowing the investment growth to grow in a free market, businesses have been able to build huge corporations.

Corporations are governed in much the same way today as they have been governed for hundreds of years. At the head is a board of directors. That body appoints or hires officers who, in turn, manage the day to day affairs of the company. Shareholders in the company elect the board of directors from time to time.

Governed this way, the corporation is a separate legal entity. Individual shareholders are not sued individually for the negligence or wrongdoing of the corporation.

The same held true for the directors and officers. As long as the directors and officers did not steal or engage in fraud, there was no individual liability for directors – meaning, in the event of a lawsuit, the directors’ personal realty and property was safe from seizure and judgment.

However, this began to change in the twentieth century. Beginning in the 1890’s and continuing throughout the 1930’s as anti-trust and securities regulation came into existence, there was an increasing body of regulation and laws for which a director or officer could indeed be held individually liable. Whether because the act or omission was perceived as fraud, neglect, or a wrongful act, the risk of individual liability on the part of directors and officers has grown.

Where a risk exists, insurance companies create a product to address the risk. Directors and officers insurance (D&O coverage) is business insurance designed to cover the risk of the individual liability of a director or officer from lawsuits (and some regulatory actions) undertaken by shareholders, regulators, state investigators, or others alleging wrongdoing on the part of the board. It is an incredibly valuable product today because it allows companies to attract top-level director talent. For example, a charity can attract very skilled people to its board if the potential board members know their personal assets are protected.

The whole scope of D&O coverage is the subject of books and treatises and can’t be covered in detail here. An insurance professional can help you determine what is needed for your company or organization.

D&O coverage needs to be looked at in conjunction with a concept called indemnification. Indemnification is where one party agrees to pay for or “indemnify” another party if that party ends up paying for something as a result of the relationship between the parties. For example, a company may offer – as part of the director’s agreement – to indemnify the director if they are sued. The company may offer to pay legal fees and costs and any judgment. For many, many years most states had laws preventing companies from indemnifying their directors. The fear was that a director could then do whatever they wanted without fear of financial liability.

That changed over time. Most states now allow for indemnification of directors.

D&O coverage reflects the indemnity possibilities and is broken into parts depending on indemnification. These different coverages were – at one time – put on different sides of the page. And so, the names, “Side A,” and, “Side B,” coverages became part of the common language of D&O coverage.

1. Side A Coverage – This coverage protects directors and officers from personal financial liability when the company cannot indemnify the director or officer. This can happen during bankruptcy or dissolution.
2. Side B Coverage – This coverage protects the company when the company indemnifies the directors and officers. For example, when shareholders file suit against the directors.

Most policies are now combined and the “two sides” are typically two clauses within the same policy. Nevertheless, you can see the two coverages protect two different entities: directors and officers, on one hand, and the company, on the other. A third coverage clause (sometimes called Side C) will dictate what happens when both the company and individual officers and directors are named. These insuring concepts must be reviewed in detail with your insurance professional so your organization adequately understands the product.

The board of directors, the president, treasurer, and other officers of your organization are the brains of the company. Increasingly, directors face personal financial liability in an increasingly complex and litigious world. That is the purpose of D&O coverage: to lower that risk in order to attract the best brains for your company.