Directors and officers liability insurance (D&O insurance) protects against legal claims for wrongful acts performed by corporate directors or officers as part of their corporate duties. Wrongful acts include omissions, errors, misstatements, misleading statements, neglect or breach of duty. Beneficiaries are the directors, officers or the corporation itself.
Directors and officers can be personally sued by shareholders, creditors, employees, suppliers, customers, competitors or regulators. Suits can be bought for various reasons. Shareholders might sue for insider trading. Creditors might sue for misrepresenting the financial health of the company. Competitors might sue for anti-trust or unfair trade practices.
Being personally sued can be crippling for individual directors or officers. Just the risk of lawsuits might cause qualified individuals to refuse to take director or officer positions, or it could motivate existing officers or directors to act with excessive caution in pursuing a corporation’s interests. By insuring directors or officers against personal liability for their own wrongful acts, directors and officers insurance addresses these concerns.
D&O insurance has been criticized for undermining corporate governance by eliminating a strong disincentive for illegal or unethical behavior. Insurance companies understand that, by writing a D&O insurance policy, they facilitate the sorts of wrongful acts they are insuring against. Accordingly, they tend to scrutinize a corporation’s corporate governance safeguards as a part of the underwriting process.
Lloyds introduced the first D&O insurance policies in the 1930s. Insureds had to pay premiums out of their own pockets, so volume grew slowly. But legal changes in the United States and United Kingdom during the late 1980s allowed corporations to pay premiums, and volumes subsequently grew.
Today, some policies are still purchased by individuals to cover themselves. These policies may be purchased by businesspeople who sit on multiple boards. Also, lawyers or accountants serving as directors or officers may purchase professional indemnity D&O policies for themselves. This covers them for professional errors and omissions that their corporation’s policy general won’t cover. In some jurisdictions, corporations aren’t allowed to pay for D&O insurance, so a corporation will split the cost with its directors and officers to comply with the law.
Policies paid for by corporations can have as many as three layers of coverage. These are referred to as the A portion, B portion and C portion—or A-side coverage, B-side coverage and C-side coverage:
- A-side coverage directly covers directors and officers.
- B-side coverage indirectly covers directors and officers by covering the corporation for claims it pays on their behalf.
- C-side coverage, also known as entity coverage, covers the corporation itself for claims arising from securities litigation or other special types of claims not covered by general liability policies.
D&O insurance policies cover claims made during the policy period. It doesn’t matter when the wrongful acts occurred. A claim arising from a lawsuit filed this year for a wrongful act committed last year is covered by this year’s policy.
D&O insurance policies tend to be customized for the unique needs of each client. Coverage is generally for some fixed level of claims per year. For example, if a large claim is paid on behalf of one director, this can leave other directors, officers or the corporation itself exposed for the remainder of the year. Policies cover damages (usually including punitive damages) and defense expenses up to the amount of coverage. Policies may or may not cover outside directors. They also vary with respect to cancelability, exclusions, and coverage for non-officer employees named in a suits along with officers or directors. Policies with C-side coverage may include language specifying some precedence for A-side or B-side claims versus C-side claims.
Most policies have an exclusion against one insured suing another. Another standard exclusion is for a failure to maintain adequate insurance. If a corporation’s headquarters burns down, and its officers had let the property insurance lapse, the corporation cannot file a claim under its D&O insurance policy.
Many corporations supplement D&O insurance policies with employment practices liability coverage (EPL coverage). This protects against claims for wrongful dismissal, failure to promote, sexual harassment and other violations of employment or anti-discrimination laws. EPL coverage may be purchased as part of a D&O or general liability policy. It can also be purchased as a stand-alone policy.
Problems can arise in a bankruptcy. If A-side and B-side claims do not have priority over C-side claims, a court may deem the policy a corporate asset, preventing directors or officers from making claims. Also, a too-broad exclusion for suits by insureds against insureds can leave directors and officers exposed to suits by bankruptcy trustees, federal or statutory receivers, or debtors-in-possession.