In today’s litigious environment, Directors and Officers liability insurance is an effective method to minimize the risks business leaders may face. In the past, D&O insurance was typically reserved for larger companies with a visible Board of Directors. That is no longer the case – Directors and Officers of even the smallest organizations can be sued for their business practices.
Directors and Officers can be held personally responsible for their business conduct. Corporate shells may protect some of the assets of a company, but do not typically protect the assets of the individual owners, officers or directors. An unfair business practice can be as simple as making false or misleading statements about your product, using predatory pricing or failing to back a company warranty. Outlined below are three important reasons why a private company should purchase D&O insurance:
Mergers and Acquisitions
During an acquisition, proprietary information from each company will be disclosed. The acquiring company will purchase assets and provide cash, securities or a combination of the two. Investors, creditors and employees of the acquired company may or may not be involved in the sale.
Many D&O claims arise from these investors, creditors or employees claiming the amount paid was not sufficient or not at arm’s length. In one example, our client acquired a company that subsequently went through bankruptcy. Even though it was an asset purchase and both parties indemnified each other, creditors of the now bankrupt company sued our client for unfair business practices. They claimed that the company was undervalued at the time of purchase and that the acquiring company was trying to defraud investors. In an acquisition, this goes against conventional wisdom and is the very reason companies’ acquire assets and not all the stock or liabilities of a company. In this case, the creditors sued for almost $1 million, but the case was eventually settled for about $200,000.
Most employees are hired because of their experience and ability to do a specific job. New employees offer an inherent knowledge of their experiences, contacts and the market in which they work – which often comes from another company. For example, a common claim involves hiring a new salesperson that brings their account list with them. Soon after hiring, they begin soliciting clients from their former company. The former company sues for the loss of revenue, reputation and the time associated with repairing their image. Even though the new company has no idea what the new agent is doing, they are held liable. The damages awarded often depends on how active the new company was in the process. In one case, the plaintiff was awarded over $3 million.
Conflicts of Interest
In smaller companies, Board Members are selected because they are closely involved in the company. As a Director or Officer, these members are responsible for oversight of the company in the fairest way possible, both to investors and to the public at large. The company may have a long standing practice of entering into contracts or joint ventures with these individuals. In the event of a bankruptcy, merger or the failure of the company to honor its obligations, plaintiff lawyers will look at all transactions – including those which may have involved Board Members. The Board should be held to a very specific conflict of interest policy. Any payments to related parties require scrutiny and Board approval and should be at arm’s length to the company. Boards should specifically choose vendors that are not related to the company and avoid any conflict of interest.
Unforeseen risks like these can be avoided by making sure your company has the proper protection. The best D&O coverage is one specifically built to protect your company’s leadership and board members.