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The Exposures Directors and Officers Face
Unlike general liability insurance -- which any organization realizes is invaluable to their operations -- many are unaware of how important the need for D&O coverage has become. When a person becomes a board member of a mutual organization, they assume a level of responsibility for the organization ("duty of care"), and exposures to claims for breaching their duties to oversee the direction of the company in a proper way.
Claims generally fall into two categories: bodily injury (physical harm) and non-bodily injury (non-physical harm, like discrimination or termination). The majority of claims are for bodily injury. Your general liability insurance covers board members, subject to policy terms and conditions, for claims arising out of bodily injury and property damage.
Directors & Officers liability insurance only covers non-bodily injury claims. Non-bodily claims include employment-related claims and mismanagement of the organization.
Fear of non-bodily injury lawsuits would be one reason to have D&O insurance. Although there are very few reported cases against mutual insurance companies, it doesn't mean that claims have not been filed and then either settled out of court or dropped. Whether the claims are frivolous or real, defense cost can present an enormous financial burden to all parties involved.
Generally, there are two types of lawsuits in which a claim might be brought against a board member: derivative lawsuits and direct or third-party lawsuits.
Derivative lawsuits are claims against a board member on behalf of the corporation. The typical claim here would be mismanagement of assets. But, under many state laws, only a few people have "standing" or the right to bring such claims. They are: 1) board member(s) suing other board member(s) 2) members of an organization suing a board (if at least 5% of the total membership join the lawsuit), and 3) the state Attorney General.
Because of these restrictive standing rules, very few derivative claims are ever made. It should be noted that claims of these types are not made for awards to an individual, but rather to make the corporation "whole."
Direct or third-party lawsuits are brought by an employee or by a person not connected with the corporation who asserts a claim against it or its board on account of some non-bodily injury.
Employment practices like termination and discrimination are the largest exposure in these types of claims. If you have a small, friendly staff, and feel unlikely to have employment claims resulting in a lawsuit, you might not think it necessary to carry D&O insurance with an Employment Practices Liability endorsement. However, when employees feel they have been wronged and are angry, they may file a claim even if it is baseless. At that point, you will have to hire lawyers. Your endorsed D&O policy then becomes a legal defense policy.
It is possible to view D&O insurance as essentially legal defense insurance, noting that 99.99% of the cases brought against a board are going to be thrown out, but you're still going to have to pay the legal fees if a claim is filed."
In this connection, the "deep pocket" theory is relevant. This theory holds that only people with money are more likely to be sued. Lawyers may file a suit based on a bogus claim against "deep pocket" board members with the hope of securing a settlement for their client.
If an organization decides that it needs D&O insurance, they should be aware that D&O policies vary greatly, unlike general liability policies which are somewhat standard. Some policies are exorbitantly expensive and often have serious coverage limitations. When shopping for a policy there are three major items to keep foremost in mind: who is covered and who is not; does the policy also cover the entity, as well as the director; what types of lawsuits are excluded from coverage; and what is expertise and financial strength of the underwriter.
Scott St. Clair
Business Development Manager
NAMIC Insurance Agency
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