Each week, I take a common question I get from clients and prospects about insurance and answer it. If you have a question you would like me to answer please feel free to shoot me an email at firstname.lastname@example.org.
The question today is – “Why do I need Directors & Officers (D&O) insurance?” A similar question is, “I don’t have a board of directors so why do I need D&O insurance?”
These questions which often get asked together are geared toward private companies. It should be fairly obvious why a public company would need D&O insurance, but if not, the objective of both private and public company D&O insurance is the same…to protect the personal assets of Directors and Officers. When you are a public company the risk is much greater. Now let me explain why you need D&O and what it can protect you against.
Let’s start with companies that are startups and have no Board. There are no outside investors yet and perhaps no product, but even then you could be at risk because claimants can be much more than just shareholders. Claimants can include competitors, regulators, creditors and even customers to name just a few. Here are some examples of how a claim could arise from someone other than a shareholder:
- Recruiting a top sales executive from your competitor who was under contract could result in your competitor filing a suit against you
- Claiming your company has the only approved product in the marketplace when it is not and your sues alleging false advertising.
- Creditors allege your devised a plan to divert assets prior to filing bankruptcy.
These are just examples and there are plenty more, but notice that none of these claims were shareholder claims. Many times insureds have done nothing wrong but that won’t prevent a claimant from filing suit. In that case the D&O policy will respond and pay your legal fees up to the policy limit. As you can imagine, the costs just to defend claims, even if frivolous, can pile up quickly. Remember the objective of the D&O policy is to protect your personal assets, a claim does not have to be successful for your personal assets to be at risk and bankrupt your company.
Oftentimes clients tell me, “I am just a small company and no one would bother suing us” or “I have run five companies prior and never had a D&O claim.” First, if you cause financial harm to another company, a creditor or any other third party no matter how small, you are at risk because people do not like to lose money. If they speak to an attorney the probability of action against you and your company increases exponentially as do the potential costs. Just because you have never had a claim does not mean it won’t happen in the future, D&O claims are infrequent but when they occur they are expensive. The average claim cost (award and legal fees) is well into the six figures. Most companies that have had D&O claims could have at one point said they never had a claim before either, but in a litigious world the odds of a claim occurring are only increasing.
Once you start raising money and have outside investors the opportunity for claims increases substantially. A large number of companies fail or lose value and this can lead to claims even if you went out of business for reasons out of your control. As you raise money you typically put together a board of directors and at this point you usually don’t have a choice on whether to carry D&O insurance, prospective board members will require you carry D&O and may even stipulate the limit you need to carry if you want them to sit on your board.
At the end of the day, D&O insurance should be in place if you have any personal assets (house, cars, etc.) to protect. As an officer or director of a company you can be named in a suit so regardless of how your business is structured you are still at risk. What is often overlooked by brokers is explaining to clients what D&O covers. If clients knew the risks that are covered by a D&O policy they would be more open to securing this coverage and less confused on why they actually need it.