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Directors and Officers Insurance Claims

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It's a fact of life, these days: People who are in senior management positions or who have seats on boards of directors are common targets for lawsuits.

There are two reasons for this:
The first is that corporate officers and directors have to make tough decisions. The nature of corporate leadership means that officers must constantly balance their obligations to clients and customers against employee interests, government regulators and ultimately to their fiduciary duty to shareholders themselves.

The second reason is that plaintiffs' attorneys perceive them to be deep pockets.

The result, of course, is that directors and officers need an additional layer of insurance protection - to protect themselves from shareholder lawsuit. In most cases, the obligation of the director or manager to the shareholders is fiduciary. That is, the executive or director owes a duty of utmost good faith to fellow shareholders who elected him or her. This is a laudable standard - but it is also the legal standard that leaves directors and corporate officers most vulnerable to shareholder lawsuits.

Directors and officers insurance (D&O) is a form of liability insurance designed specifically to protect senior executives and board members against damages arising from shareholder lawsuits - despite doing their best to act in good faith. D&O policies pay a cash benefit to the officer to indemnify him from losses arising from lawsuits from shareholders.

These policies aren't limited to directors and executives of publicly held corporations. Liability can accrue to directors of non-profits, closely held corporations, REITs, homeowners associations, condo associations, and anywhere else where a fallible human is formally entrusted with other peoples' wealth.

Common claims

What kinds of things are shareholders suing over? Some of them are obvious: A breach of fiduciary duty.  For example, a board member voting to direct company business toward his landscaper nephew, despite the conflict of interest.

Other claims involve allegations of more technical violations of the compact with shareholders. For example:

  • A failure by the Board to adhere to its own by-laws.
  • A failure to schedule elections or count votes properly.
  • The improper election or removal of the member of the Board of Directors
  • Improper dismissal or failure to hire an executive or employee.
  • Decisions that lead to a decline in stock prices or asset value.
  • Board decisions that led to the damage of one or more members of an association.
  • Failure to maintain the common areas of a condominium complex or housing development.[i]

Accusations can come without warning - and even board members acting in good faith can make mistakes. D&O insurance transfers the risk of making a mistake from the individual board member or officer who cannot afford the cost of a judgment or settlement to the insurance company, which can.

Meanwhile, many D&O policies will also pay the costs of a legal defense.

Note: D&O does not cover bodily injury claims. These would fall under general liability insurance claims.

Real world examples

In one case, a group of donors to a church sued the Board of Directors of the church itself - accusing them of deliberately misrepresenting the church's financial condition. There were a total of three lawsuits against the church. The first two settled, while the third lawsuit paid nothing to the plaintiff. But even the lawsuit that paid nothing racked up $13,000 just in defense costs. The total damage from the three lawsuits amounted to $216,000 in legal fees alone. The total cost to the church's Board of Directors was over $530,000. [ii]

In another case, a group of non-insider investors in a corporation sued, alleging that some directors and officers failed to disclose facts that were material to the investment decision. Specifically, they accused them of not disclosing the high manager turnover rate, and the fact that they had not developed the company website yet.

In some cases, corporations offer to indemnify directors against personal liability. However, in this case, the company declared bankruptcy - which illustrates the limitations of this technique.

The case was settled for $1 million. The defendants spent $1.4 million defending themselves.[iii]

Directors and corporate officers have come under increasing fire from a variety of directions. A surgeon wouldn't think about operating without malpractice insurance in place. Corporate executives and directors generally shouldn't make decisions in an uncertain environment without at least some protection of their own.

Note: D & O insurance does not cover criminal acts or intentional and egregious wrongdoing. The policies are designed to protect those who act in good faith.
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