Does Your Business Need Directors and Officers Insurance?

Small businesses and private companies need many kinds of business insurance. The standard business owner's policy (BOP) provides general liability coverage, which may be enough for most small companies.

As your company grows, your officers and directors may face liability for decisions they make on behalf of the company. Customers, vendors, employees, and even other partners and directors can bring legal action against the directors. When you incorporate your small business, you need a particular type of insurance coverage, known as directors and officers liability insurance.

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What Are Directors and Officers?

Your directors and officers are the ones who make decisions and manage your corporation. In a small company, they may be the small business owners themselves. Under the rules of incorporation, you must have company officers and a board of directors with board members to be a "corporation."

Corporate officers make financial decisions for the company. They are fiduciaries to the company and one another. As fiduciaries, they have duties to the company and its board of directors. A fiduciary duty means acting in the best interest of another party, in this case, the company. Directors and officers have a duty of care to act as reasonably prudent people when making decisions.

When officers fail to act in the company's best interest or do wrongful acts, the company is liable. Ordinary small business insurance may not cover the financial loss. The business shields a corporate officer from liability. For this reason, corporations need directors and officers coverage or D&O insurance.

Reasons for D&O Insurance

Most corporations indemnify their directors and officers against liability for their actions. This means the company gives the officer legal protection against acts performed on behalf of the company. Indemnification isn't always sufficient protection for the corporation. If the company must sue the officer, indemnification will not apply.

D&O insurance policies provide coverage for:

• Mismanagement of funds: This is also known as breach of fiduciary duty. Shareholders and the board of directors can sue members who misuse funds or misrepresent investments.
• Regulatory noncompliance: Government agencies can sue private and public companies for violating federal regulations. If the violation was due to board errors or omissions, D&O coverage pays legal fees and fines.
• Employee legal action: Employees can file lawsuits against the company for a number of reasons. Discrimination, wrongful termination, and workers' compensation violations are grounds for action.

Without D&O liability insurance, the officers and company must bear the entire cost of any legal action against the officers or directors. Any breach, misrepresentation, or even theft of intellectual property can lead to a personal lawsuit.

Types of D&O Insurance Policies

A D&O insurance policy has three basic parts. You should discuss which parts you need with your insurance company representative since not all companies will need each portion.

Side A Coverage

This part covers officers and directors who aren't indemnified. If a company can't indemnify its officers, their personal assets are at risk in a lawsuit. Side A coverage protects these individuals during a suit against the company.

Side B Coverage

This covers indemnified directors and officers. The directors and their personal assets are insured during the legal action, but the corporate assets are at risk.

Side C Coverage

This coverage is also known as "entity coverage." Side C coverage protects the corporate entity. This insurance protects the company itself during a suit against the business and officers.

In general, D&O insurance covers only lawful acts carried out by the directors and officers. Illegal acts such as fraud are not covered. The D&O policy doesn't cover any lawsuit that other insurance covers. For instance, general liability insurance covers property damage claims, and professional liability covers malpractice cases.

Getting Legal Help

You may be unsure if your business is ready for directors and officers insurance. Before deciding, review the potential costs and benefits with a business and commercial attorney near you.