The Importance of Private Company D&O Insurance

Directors and officers liability (D&O) insurance protects the personal assets of business leaders and is a crucial component of a comprehensive insurance portfolio. Although there is a common misconception that D&O insurance is only needed for publicly traded companies, directors and officers of privately held companies could also face D&O claims from multiple parties.

Considering these exposures, it is crucial for organizations to secure proper D&O coverage. This article examines the unique risks private company leaders face and provides an overview of key benefits of D&O insurance for private companies. It also explores the scope and structure of private company D&O policies and discusses strategic considerations for these organizations.

Unique Risks of Private Company Directors and Officers

D&O insurance is a type of liability coverage that shields business leaders’ personal assets if they are sued for decisions made while managing a company. The allegations may originate from multiple parties, such as:

• Shareholders
• Employees (past and present)
• Creditors
• Clients
• Vendors
• Competitors
• Regulators

Common allegations against directors and officers include:

• Breach of fiduciary duty
• Conflicts of interest
• Financial reporting errors
• Regulatory violations
• Misuse of trade secrets
• Asset mismanagement
• Unfair business practices
• Anti-competitive behavior
• Breach of contract

Claims can also arise during major events in a company’s evolution, including mergers and acquisitions and going public. These transactions often lead to heightened litigation risk, including shareholder suits, regulatory scrutiny and fiduciary duty claims. Bankruptcies are also a common time when allegations arise.

Key Benefits of D&O Insurance for Private Companies

Private companies can receive several benefits from D&O insurance coverage, including:

• Personal asset protection—D&O coverage safeguards business leaders’ personal assets if they are sued for decisions they made on behalf of the organization. Since leaders of private companies are typically more involved with all facets of a business, it may be more likely that they are individually named in litigation. Without D&O insurance, these individuals could be held personally liable for court costs, settlements and judgments, placing their houses, personal finances and other assets at risk.
• Corporate balance sheet protection—D&O insurance can help cover a business’s expenses related to claims against its directors and officers. This financial assistance can preserve the organization’s financial health.
• Indemnification supplement—Businesses that indemnify their leaders may still encounter legal and financial limits. D&O insurance can provide supplementalcoverage for situations where indemnification is not possible (e.g., bankruptcy) and allows for continuous protection.
• Talent acquisition and retention—Offering D&O coverage helps attract top leadership professionals who often expect coverage as part of their compensation package. Additionally, D&O insurance may offer reassurance to current business leaders that the organization supports them.
• Peace of mind—Knowing D&O insurance is in place can allow directors and officers to make decisions without the fear of encountering personal liability. This confidence extends to the organization as a whole, fostering a more stable and innovative company culture.

Scope and Structure of Private Company D&O Policies

To make fully informed decisions regarding their insurance posture, organizations should carefully examine D&O policies and know what they cover. The following are key aspects of D&O insurance:

• Side A, B and C coverage—D&O insurance is generally divided into three components that cover different scenarios:
  • Side A coverage offers direct personal protection for when businesses cannot provide leaders with indemnification (e.g., bankruptcy or legal restrictions).
  • Side B coverage provides reimbursement to the company when it indemnifies its directors and officers.
  • Side C coverage is also known as “entity coverage” and applies to a broad range of claims against a private company when the entity itself is named in a lawsuit.
• Broader coverage than public company D&O policies—D&O policies for private companies often provide more exhaustive coverage for claims than those for public companies, which heavily focus on shareholder lawsuits or securities claims. This wider scope of coverage reflects the various legal exposures private companies face, including claims from vendors, competitors or customers, and often extends beyond litigation to other proceedings (e.g., arbitration).

When reviewing policy options, it is important to understand:

• Exclusions—Most D&O policies exclude coverage for fraud, criminal acts, antitrust violations and breach of contract. However, policies typically advance defense costs for these allegations until a final adjudication establishes that such acts occurred. Some defense costs related to breaches of contract may also be covered if the allegations involve related wrongful acts, depending on the policy’s terms.
• Cyber risks—Cyberattacks and data breach costs are generally excluded from D&O policies and are covered by separate cyber liability policies. However, claims alleging directors failed to oversee cyber risk management may still fall within D&O coverage if they allege mismanagement or breach of fiduciary duty.

Private companies can often negotiate coverage terms to ensure the policy best suits their needs. Working with experienced brokers or legal counsel can help ensure the coverage properly aligns with the business’s risk profile and governance structure.

Strategic Considerations for Private Companies

Private companies should keep several strategic considerations in mind as they analyze D&O coverage. For example, D&O insurance is crucial in supporting long-term goals, including meeting investor expectations and supporting growth. Investors often require robust D&O insurance to be in place before investing because it demonstrates the company is serious about risk management and safeguarding leadership. D&O insurance is especially important during mergers and acquisitions and the initial public offering readiness stage because these processes intensify the scrutiny of leadership decisions.

Furthermore, regularly reviewing coverage limits and exclusions is essential, as a company’s risk profile is constantly evolving (e.g., expansion to new markets, new board members, additional funding). Undertaking these reviews helps ensure the policy aligns with the business’s size and revenue and does not contain gaps in protection as new risks emerge.

To ensure optimal protection, businesses should work with an experienced insurance professional and take the following steps:

• Benchmark coverage against peers to assess whether policy limits and terms are competitive.
• Consider layered coverage or excess policies for additional protection, especially in high-risk sectors or during rapid growth.

Conclusion

D&O insurance for private companies offers numerous benefits and is integral to an organization’s risk management strategy. By ensuring the proper coverage is in place with adequate limits and terms, a business can safeguard its leaders, foster confident decision making, recruit and retain top talent, and position itself for continued success.

Contact us today for more information.

Article Published By: Zywave, Inc.