Privately Held Company - Directors and Officers Coverage



For privately held companies directors and officers coverage(D&O) has become a mandatory coverage to attract high caliber board members. Directors and Officer insurance coverage is put into place to protect the board members against acts of negligence committed while acting in the capacity of an organizations executive board.  The duties of a board are to perform their services with loyalty, obedience and diligence.  Managers of privately held organizations and even nonprofit groups are particularly exposed to directors and officers claims because of their intimate knowledge of a companies day to day operations.  Typically privately held organizations have not put the same measures in place, i.e. segregation of duties, that a publicly held organization would to comply with federal law (Sabranes Oxley), SEC Compliance, laws associated with raising funds, employment regulations and other measures.  Even when performing the duties of a board member to highest possible standards it is possible for claims to arise.

Just as is the case with publicly traded companies, the personal assets of a director or officer of a private company may be at risk if a company can not indemnify its board members either because of the nature of the allegation or due to financial issues such as insolvency.  Sarbanes Oxley which use to only be applied to publicly traded companies is now being broadly applied to all business which has changed the nature of litigation against directors and officers.  In fact, in a recent New York court decision it was held that directors and officers of a privately held company had the same fiduciary duties as those serving a public company.

Who can file a D&O Claim

Directors and officers policies can be triggered from within and organization, when an employee files a claim against a director or officer, or from outside an organization.  Claims that arise inside a company from an employee could be the result of any of the following examples, breach of contract, retaliation(Whistleblower), harassment, employment discrimination, and wrongful termination.  Another source of claims can come in the form of alleged wrong doing while acting in a corporate capacity and can involve investment decisions, management failure to perform, acting in self interest, making decision detrimental to the company, failure to raise capital, and decisions to acquire other companies or merger.  A claim can be filed against a director or officer by creditors, shareholders, customers, vendors, competitors and even the federal government.

Directors and Officer Coverage - What to know about Directors and Officers

Directors and officers coverage is a specialized coverage not written on a standard form which means that many of the coverage elements are specific to certain carriers. I work with underwriters directly to position my clients and understand how D&O should protect their company.  There are two particularly important and often negotiable clauses in Directors and Officers policies.  One is the so called "hammer clause" deemed this term because when invoked by the insurance carrier the case is settled with or without the clients consent.  Below is an example of how a company can choose to fight against the "hammer clause" and the cost they can incur, or you can take a look at a recent case where the "hammer clause" was invoked by the carrier although the client wanted to continue to fight against the baseless lawsuit.  American Apparel vs. Woody Allen

Example of Hammer Clause in Effect

With Hammer Clause Without Hammer Clause (Negotiated by broker w Carrier)
Offer to settle at $200K, No settlement reached  Offer to settle at $200K, No settlement reached
$20K Retention (i.e. Deductible) $50K Retention (I.e. Deductible)
Defense cost $1MM, Insurer pays only up to limit of settlement offered = $200K Defense cost $1MM, Insurer pays only up to limit of settlement offered = $200K
Cost to Insured $800K plus retention for a total of $820K Cost to Insured $0 for defense plus retention of $50K
Total cost $820K Total cost $50K

In the above example you can see how important is is to have the "hammer clause" negotiated or removed should your business suffer from an early settlement on an claim.  Examples of companies that can be harmed by legal president establishing a cause for lawsuits such as Franchisors, any company that is subject to class action lawsuits and as in the above example a company who has used images under its first amendments rights.

Directors and Officers - Examples of Loss



Private Company - After Seven Years, Lawsuit Arises

Cause of Action Breach of Fiduciary Duty, Fraud
Type of Organization Private
Number of Employees 100
Annual Revenue $16.4 MIllion

Context of Suit

The CEO of a newly forming company, Widget Co., induced Investor A to purchase a minority interest in the company by promising a substantial return on investment and substantial dividends.  Nearly seven years later, Investor A sues Widget Co., and it's CEO alleging fraud, failure to comply with corporate by-laws, exclusion of a minority shareholder from profits, squandering company assets, and breach of fiduciary duties.  Investor A demanded that corporate records be opened for inspection and that Investor A be awarded damages of $600,000.  In its defense, New Co. said there was no wrongdoing and claimed that no loss had been suffered.

Resolution   

The parties settled for $180,000.  Widget Co. incurred $50,000 in defense costs.

Other D&O Policies: Publicly Held Company Directors and Officer, Non-profit Directors and Officer

Insurance Companies writing Directors and Officers Coverage (D&O)



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