If the answer is yes to either question, you could be exposed to lawsuits from shareholders. They may sue you, alleging that you committed acts that reduced the corporation’s value. Lawsuits may also arise out of employee practices, allegations of conflicting interests, and from providing information to the investing public.
Decisions made by directors and officers impact the viability and value of a corporation. The current issues of accounting practices, financial reporting, and the use of corporate assets have resulted in an increase of lawsuits being filed against executive boards. Directors and officers (D&O) coverage should be considered a necessity for corporate entities. D&O coverage supplements the protection provided by general liability policies since the former responds to legal actions filed by shareholders, customers, scorned merger partners, and creditors.
Corporate directors must take steps to determine whether D&O coverage exists. If D&O coverage is in place, boards should also determine the amount of coverage available for handling defense costs. Any amounts paid for legal costs are subtracted from the overall policy limits and are not a separate coverage. Criminal acts are not covered by D&O insurance. However, the cost of providing a legal defense until criminality is determined may be covered. In the past, it was common for a director facing a lawsuit to have any related expenses handled by a corporation’s operating funds. Today, such agreements have little value, especially for operations facing bankruptcy or those that cease operation.
The increase in shareholder lawsuits has created a much tighter market; the application is typically completed by one or two key executives. Both the applicant board and the insurance carrier rely upon the accuracy of the information provided by the persons completing the application. A problem arises because of how an insurer relies on the information. Typically, the insurer treats the information given by one or two persons as though it were received by all of the persons on the board. Insurers often either deny coverage or deny claims when there is evidence that the information is inaccurate. In other words, fraud or errors caused by an individual officer or director could eliminate coverage for all other directors and officers.
When coverage is not available or if it is denied, a director or officer may face the financial nightmare of having to handle his or her own legal expenses and costs of an award. Therefore, it is very important to ensure that a D&O policy provides the anticipated protection. It is also important that a board takes steps to oversee the application process and to make sure that the provided information is accurate. Another step may be to look for D&O coverage that offers separate coverage to directors and officers so innocent parties do not have their protection stripped away due to the deliberate false actions of others.