Do You Need D & O Insurance?

Directors and Officers liability insurance policies (“D & O Coverage”) are becoming both more expensive and more difficult to obtain in the post-Sarbanes-Oxley world of corporate responsibility. We are often asked whether the protection afforded by D & O Coverage is worth the effort and expense of obtaining or maintaining such coverage. Our answer, in most cases, is that “it depends.”

First, what is D & O Coverage? Generally D & O Coverage insurance covers claims arising from alleged wrongdoing by directors and officers in their official capacities. Typically these policies will pay for defense costs as well as the cost of settlement or judgment. Most D & O policies define a covered claim to mean demand letters, civil complaints, and administrative or regulatory proceedings commenced by a notice of charges. Not covered by most such policies would be a criminal investigation or proceeding, subpoenas for information or testimony, or defending against an SEC investigation. However, many of these non-covered claims can be brought into coverage by an “expanded claims endorsement.”

Does a private company need D & O Coverage? If there are shareholders other than the Directors and Officers, the answer would generally be “yes.” Even if there are no “public shareholders,” the presence of any other shareholders who may take issue with corporate management would indicate the advisability of D & O Coverage. This would be particularly the case of the corporation anticipated any capital raising or M & A activity.

Often, D & O Coverage for a private company can be obtained with lower coverage amounts and lower retentions (i.e., deductibles) than for a public corporation.

The amount of coverage needed and the appropriate amount of retention are questions that do not lend themselves to simple answers. The goal here is to provide enough coverage for reasonable settlement amounts and defense costs, both of which count against policy limits. The appropriate coverage amounts will depend upon such factors as the company’s market capitalization, the volatility of its stock price and recent public securities offerings. Retentions should not exceed an amount the company can afford to pay from its ordinary cash flows.

Should you purchase “entity coverage” for the company in addition to coverage for the individual officers and directors (since most lawsuits name both the company and the individuals as defendants)? By covering both the company and the individuals, issues relating to allocation of settlement payments and defense costs between the company and the insurer can be avoided. Note, however, that entity coverage only provides protection for the company against securities class actions; i.e., it generally does not apply to shareholder derivative actions, SEC investigations or enforcements, or cases alleging breach of fiduciary duties.

If you have any questions regarding any aspects of your corporate insurance protection, please contact Jim Rench or your Stark & Knoll attorney at 330-376-3300.