Most public companies don’t need to be persuaded that their company needs directors and officers insurance. However, the matter is viewed differently by some private company managers, particularly those at very closely held companies who believe they are unlikely to ever have a D&O lawsuit. Private companies are sued everyday – sometimes for events that are outside the scope of coverage of the general liability, employment-related practices liability, or fiduciary liability policies. Executives who have survived a claim know better; too many company officials learn the hard way that when they recognize they need insurance after all, it is too late.
Many who resist the need for D&O insurance are affiliated with companies that have few shareholders. They look at their ownership and conclude their company could never have a D&O claim. This perspective overlooks the fact that the array of prospective D&O claimants is broad and includes customers, vendors, competitors, suppliers, regulators, creditors and others.
When a company has a claim, expenses mount quickly. Even frivolous suits can be expensive to defend. At the same time, the cost of private company D&O insurance is relatively low.
A look at the D&O policy for private companies reveals that it is usually written on a duty to defend basis. This is much broader than the duty to indemnify. Under the duty to defend coverage, the carrier appoints defense counsel and takes care of managing the claim. The policyholder doesn’t have to deal with legal bills and so on. Another advantage of duty to defend coverage is that, in general, if any part of the claim is covered, the insurer must defend the entire claim, even those parts that are not covered. The duty to defend is a valuable coverage that can easily exceed the cost of the policy. Without this valuable coverage, many companies would actually go bankrupt just from the associated legal costs, even if the suit were groundless.
Consider the situation where an individual employee or director is named in a suit. If the company attempts to have the individual named in the suit removed and the company is in weak financial condition, the court is less likely to approve the removal because of concern that the weak financial footing of the company would remove the possibility of payment to the plaintiff should the plaintiff prevail in the suit.
A hidden cost of the D&O lawsuit is the time that is consumed in preparation and defense. This can cost the company substantially in terms of lost production, lost opportunity costs and dissatisfied customers.
The level of expertise in handling these types of claims must also be taken into consideration. Insurance companies handle these types of cases frequently. The expertise required in this specialized field of law can make or break the success of a case. One very important benefit to having D&O coverage is being able to utilize the expertise of the insurance company.
D&O insurance for private firms is materially broader than it is for public companies. The entity coverage in public company D&O insurance policies is generally limited just to securities claims, while private company policies contain no such limitation, thereby providing significant financial protection.
Private company D&O insurance provides broad coverage at relatively low cost. Thus, it should be a part of every private company’s risk management portfolio – not just private firms with a broad ownership base.
Sources: PIAA, Insurance Journal