Private companies often underestimate their need for director and officer (D&O) liability insurance. When they do, it can put the company and its key players at significant financial risk. Today's tightening credit market and expanding notions of employment practices liability have created fertile ground for certain types of actions against directors and officers, but a soft insurance market has made coverage more affordable. Consequently, it is an opportune time for private companies to take a closer look at D&O coverage.
 

 Consider this scenario: A group of entrepreneurs develops a plan to build an ethanol refinery in the Midwest. They find investors who contribute $10 million in seed capital. The entrepreneurs add another $10 million from their own pockets. Try as they may, they just can't secure the necessary additional, permanent financing to get their start-up off the ground. The project dissolves, but the seed capital is gone. The investors file a lawsuit to recoup their losses, even though the capital they invested was spent for legitimate reasons and they knew of the risks involved. They allege the entrepreneurs breached their duty of care and failed to properly manage the project. Whether the investors prevail, those entrepreneurs will be on the hook for defense costs and possibly much more.
 
 A scenario like this might not make headlines, but it illustrates one example of why private companies—and not just publicly held firms—need D&O coverage as part of their insurance package. The directors and officers of private companies bear many of the same responsibilities and face the same risks as their counterparts in publicly traded corporations. Without the right D&O policy in place from the inception of any business, both the company, and its directors and officers, are taking unnecessary financial risks.
 
 D&O Basics
 D&O insurance is designed to cover claims based on the actions of a company's directors and officers. In private companies, these individuals often are active, hands-on business executives. They wear many hats, from hiring and firing manager, research and development guru, to dealmaker-in-chief. Because they are likely to do such a wide array of tasks and be deeply involved in daily business operations, their actions are more likely to be called into question by shareholders/investors, employees, competing companies, customers or governmental agencies.
 
 The cost of defending claims of wrongdoing can quickly add up, even if an allegation does not result in a legal judgment or settlement. Sometimes the costs are more than a business can absorb, and bankruptcy results , or the claimant looks to the personal assets of the directors and/or officers, if the company itself cannot, or will not, pay or provide indemnification to the individuals named in a claim. This puts private companies' directors and officers, and their spouses and estates, at financial risk.

 
 Individuals who serve as directors and officers are becoming more aware of their personal risks in their corporate governance roles. An annual survey by Towers Perrin, a global professional services firm, reported that in 2006 public and private companies—more than 65 percent of those surveyed—received a record number of inquiries from potential board members who were concerned about their current D&O liability insurance. Companies may find that they need to provide appropriate D&O coverage in order to attract the right individuals to serve in key positions.
 
 Sources of Liability
 D&O insurance can help to protect a company and its directors and officers in a variety of situations. New causes of action seem to be created all the time, but the following describes an essential few that private companies should consider.
 
 › Claims by shareholders/investors Aggressive capitalization is common in the energy sector, creating risk as soon as a company is formed and investors' money is starting to be pulled together. This illustrates the importance of having adequate insurance coverage from business inception. As the credit market tightens, deals will be harder to put together, increasing the potential for these types of claims.
 

 Shareholder claims can also be based on allegations of misrepresentations, inadequate disclosures, conflicts of interest, misdealing and mismanagement, and sometimes occur in connection with mergers/acquisitions. Here's an example: Start-ups in the energy sector are sometimes formed with the intention of running the business for a few years, and then selling to a larger company or conglomerate. If shareholders aren't pleased with the sale price, but perceive that key executives got a sweet deal, a lawsuit can result.
 
 › Claims by competitors These could be based on directors'/officers' roles in contracting and negotiating, or involve trade secret controversies filed by a competitor after a failed merger/acquisition or employee jumps ship to work for the other firm.
 
 › Employment practices liability claims This can include failure to hire, termination, discrimination and sexual harassment. The potential liability of employment practices claims often are underestimated, but with legal bills tacked on to a settlement or judgment, they can easily hit $1 million. Companies in the energy business tend to have large workforces, increasing the chances of this type of claim. Allegations against directors and officers can encompass not only their own actions, but also that they negligently supervised and/or failed to address complaints against supervisors.
 
 › Suits by government agencies, including those involving tax and labor laws, and environmental issues Private companies may more easily fall prey to these, especially in the early years of operation. Entrepreneurs in start-ups want to focus on the core business and may not yet have in place the support staff or outside advisors needed to navigate the legal complexities of running a business in today's world.
 
 Finding the Right Policy
 D&O coverage can be purchased with or without employment practices liability insurance coverage, but given the burgeoning number of employment practices claims, the dual coverage has become essential. Some of the other items to watch for in assessing the right policy for a company include:

 
 › No exclusions for major shareholders
 › No exclusion for failure to maintain insurance
 › "Losses" as defined in the policy should include defense costs and non-indemnifiable losses arising from "bump-up" claims
 › A panel counsel provision allows the insured to select legal representation from specialized firms at pre-determined rates
 › Coverage should provide a carveback for whistleblowers from the insured versus insured exclusion
 › The policy should provide non-rescindable Side A coverage, which covers directors/officers for personal liability; and full severability with regard to each insured individual for continued protection in the event of individual wrongdoing that could result in policy rescission.
 
 As noted at this article's outset, a soft insurance market has resulted in now being a cost-effective time to buy D&O coverage. However, a soft market also attracts more players to the field, making it critical for companies to scrutinize the quality of the carrier, along with the coverage offered. Make sure any carriers being considered have a reputation for responsiveness, along with claims-paying ability. A quality carrier, and a policy that includes the items noted above along with others recommended by your insurance professional, will go a long way toward providing your business, and its directors and officers, with important financial security.
 
 Scott Helmer is president and CEO of Helmer Risk Management, a leading provider of specialized insurance brokerage and risk management solutions for the energy and construction industries. Reach him at <a href="mailto:scotth@helmerrisk.com">scotth@helmerrisk.com</a> or (877) 435-6371 ext. 226.
 

 The claims and statements made in this article belong exclusively to the author(s) and do not necessarily reflect the views of Ethanol Producer Magazine or its advertisers. All questions pertaining to this article should be directed to the author(s).

Director and Officer Liability Insurance: A Business Necessity

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Director and Officer Liability Insurance: A Business Necessity