Directors and officers insurance, or D&O, protects you against lawsuits that arise in connection with the decisions that you or others make as managers of a company. You might think that won’t be a problem in your case, but the range of circumstances it protects you against is so broad that you should think again.
What is directors and officers insurance?
Directors and officers insurance (D&O) is a particular form of cover designed to protect you against the financial effects of lawsuits that arise due to circumstances that arise from your decisions as a manager of a company. It is distinct from professional indemnity insurance, which applies to advice you give in a professional capacity – perhaps as a solicitor or financial adviser, for example, or in other consultancy roles.
It is also separate from errors and omissions insurance, which applies to lawsuits arising from harm or damage caused by your products or services; and employers’ liability cover, which refers to a range of grievances by your employees. All the same, because policies may be bundled together and the lines between some of these forms of insurance can be blurred depending on the insurer and your country, it is best to check carefully exactly what circumstances your directors and officers insurance policy covers.
What circumstances does D&O typically cover?
Directors and officers insurance is a little bit like E&O for managers. If you do something in your capacity as a manager of the company that is perceived to cause harm of some kind, it is likely that this will fall under the remit of D&O. However, the list of circumstances that D&O covers is extremely broad. Aggrieved parties might be shareholders, clients or staff. Some of the areas that it includes are:
- Poor share performance and other shareholder concerns
- Employment practices. These might include:
- Unfair hiring or dismissal
- Failure to promote
- Sexual harassment
- Sexual, racial or age discrimination
- Regulatory issues
These are just some of the reasons why cases are brought against company managers. The majority of claims are settled before they get to court. However, remember that you do not have to be found liable for it to cause you a serious problem; even without a settlement, legal fees can be high enough to bankrupt even a medium-sized company. Directors and officers insurance should cover both these fees and any settlement that results from a claim. It also worth noting that the number and scope of claims has increased considerably in recent years. Currently, more than half of D&O claims relate to employment practices, with grievances by shareholders representing a growing cause of claims. Remember that D&O will rarely cover intentional errors (as with most forms of insurance).
Why do you need D&O?
Directors and officers insurance is necessary because when a claim is made on these grounds it is typically brought against both the company and its managers. This means that you are personally liable for the outcome, as well as the company being financially liable. Without the right insurance, your personal assets are at risk. This is something that few managers would entertain. D&O allows them to engage in this role without having to worry that a bad decision – or one that is merely perceived as bad – could bankrupt them. Remember, a claim doesn’t have to be well-founded for it to result in serious expense and hassle for you and your company: you will still have to pay legal fees.
When will you need D&O?
Because managers may be personally liable, most people will not take on the role of director or officer without the relevant insurance in place. You will therefore typically need to organise D&O before you convene a board of directors – they will usually insist on it as a condition of accepting the job.
Beyond this, outside investors (including venture capitalists) will want to know that you have directors and officers insurance, as well as other forms of insurance in place, before they give you their money. The reason for this is simple: they want to make sure that their investment goes towards growing your company, resulting in a return for them. If you run into problems and don’t have D&O insurance, they could find that their money is wasted on legal fees.
Because of the risks entailed in taking a management position within a company, directors and officers insurance will almost certainly be necessary to limit your liability from lawsuits by aggrieved parties. These might be clients, shareholders or employees, with the latter comprising the majority of claims. D&O should cover both legal fees and any final settlement that is agreed by the courts. Generally, you will need to have D&O in place at the earliest stages of creating a new company, and certainly if you expect to secure any outside investment.