Directors and officers today face significantly more liability than in past
years as corporate scandals become more visible. The fundamental principles
governing their conduct come under
increasing judicial and regulatory scrutiny
due, in large part, to recent corruption.
The Sarbanes-Oxley Act, which was
signed into law in 2002, expanded the
responsibilities as well as the potential liabilities of corporate officers and directors.
Although this legislation protects shareholders and is expected to improve corporate governance, it also bears the risk of
increasing the number of litigations, says
Victor Farfan, commercial insurance broker, with Westland Insurance. Increased
corporate governance has heightened the
importance of indemnification of corporations’ directors and officers.
These factors have led to the need and
development of more sophisticated Director’s and Officer’s Liability Insurance
(D&O). Smart Business spoke with Farfan
about the importance of such coverage and
how executives can make sure they are
properly insured.
What is Director’s and Officer’s Liability
Insurance?
In general, insurance policies for directors and officers provide coverage for
defense costs and liability payments (both
judgments and settlements) for covered
wrongful acts if a claim is made against the
insured during the policy period. This is
often referred to as ‘Side’ A coverage. In
addition, most policies afford coverage for
the company’s own expenses incurred in
indemnifying covered persons pursuant to
the corporate indemnity in the company
by-laws. This is often referred to as ‘Side’ B
coverage. Usually, there is a deductible that
applies to claims within ‘Side’ B coverage,
and D&O policies typically require that the
company advance defense costs and make
payment for any judgment or settlement
before the insurance company will pay.
Some D&O policies also contain ‘Side’ C
coverage for loss incurred by the company
entity. For a publicly traded company, the
entity coverage for D&O typically is limited
to claims against the company arising
under federal or state securities statutes or
under SEC rules and regulations.
A number of D&O carriers now offer
‘Side’ A only or ‘Side’ A DIC (Difference In
Conditions) D&O policies, with a dedicated limit of liability covering directors and
officers when indemnifications and standard D&O may be unavailable. One must
also consider that when various state
statutes restrict a corporation’s ability to
indemnify its directors and officers in connection with shareholder derivative
actions, coverage under ‘Side’ B D&O policies may be restricted. Therefore, it is common for directors and officers to rely on
‘Side’ A D&O policies for coverage for
shareholder derivative actions.
Why should directors and officers invest in
such coverage?
Director’s and Officer’s Insurance is the
main line of defense against ruinous jury
awards and legal settlements. There is a
chance your personal assets may still be at
risk as a result of the SEC seeking settlements that specify payments come from
personal funds rather than insurance. A
good D&O policy can provide important
protection for an innocent director or officer from honest mistakes and even fraud
committed by others.
Director’s and Officer’s Insurance premiums are falling to incredibly low levels for
all buyers, including privately held corporations. With this in mind it, doesn’t make
any sense to expose one’s personal assets
and estate to the risk of an uninsured loss.
Directors and officers of privately held corporations face the same risk as those of
publicly held firms. Avoid the risk of being
sued for complaints alleging fraud, unfair
competition, interference with prospective
economic advantage, infringement of trade
secrets and several other alleged wrongful
acts and consider how D&O can protect
you.
Why aren’t all directors and officers covered?
Many directors and officers have never
closely examined the D&O policies and
may falsely believe they are immune from
personal financial liability. The recent
exposé of corporate scandals has lead to a
crackdown on corporate malfeasance and
fraud investigated by government regulators and prosecutors. This threat of criminal fines and civil judgments has caused
D&O providers to place many limitations
on policies. Some have even attempted to
rescind policies altogether.
How can directors and officers select the
proper coverage for their industry?
The issues directors and officers deal
with will vary within the industry in which
the company operates. To ensure proper
and sufficient coverage one must make
sure all information provided to the insurer
is as accurate as possible. Outright misrepresentations and mistakes could give the
insurer all the ammunition it needs to have
a policy cancelled.
In this era of heightened regulatory
supervision and shareholder unrest, company executives need to take the time to
review the precise wording of their policies. Policyholders should review wording
before they purchase their policies. By
investing the time upfront in scrutinizing
the wording, one can be assured the protection intended to be obtained through
the purchase of a policy will be there when
the insured needs it most.
VICTOR FARFAN is a commercial insurance broker with
Westland Insurance. Reach him at (949) 553-9700, ext. 3319, or
[email protected].