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 to Farfan about this
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, 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, they
can be assured the protection intended to be
obtained through the purchase of a policy
will be there when they need it most.
VICTOR FARFAN is a commercial insurance broker with Westland Insurance. Reach him at [email protected] or (949) 553-9700
x 3319.