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Your Responsibilities as an Officer Require Review Of The Organization's D&O Insurance
John P. Beavers
Bricker & Eckler LLP
March 2000
Introduction
The purpose of this discussion paper is to provide officers and employees of a corporation, including directors who are also officers or employees, with an overview of their general obligations to the corporation.
A plethora of information exists on "directors and officers" liability. Publications have increased exponentially as have headline news about the FBI raiding the offices of Archer Daniels Midland and former directors and officers of Medical Mutual personally repaying $6.8 million to policyholders. Directors of a corporation are entitled to certain defenses and protections, such as the "business judgment rule," against potential liability. However, there is always a caveat to the effect that "these defenses and protections in no way limit potential liability for actions taken by officers and employees." So, what about officers?
The Statutory Scheme
The scheme of most corporate statutes is that directors are entitled to rely upon officers and, if they do so properly, may escape liability. Accordingly, if directors are entitled to rely upon officers, and if officers were entitled to the same defenses and protections as directors, no one would be responsible to shareholders. Most states' corporate statutes do not entitle officers or employees (including directors who are also officers or employees) to the same defenses and protections that directors enjoy.
The Common Law Duties
Some states' corporate statutes define the duties of a director, and do so to provide some protection. Most states' statutes do not directly define the duties of officers or employees. These duties are left to judicially-made common law. They include the fiduciary duties of care and loyalty. The duty of care requires an officer to exercise the care that an ordinarily prudent person in a like position would exercise under similar circumstances. The duty of loyalty requires an officer not to misuse a corporate asset, including misappropriating a corporate opportunity, for a personal benefit. Furthermore, some states' common law, like that of Delaware, requires officers to disclose all material information to the board of directors in order to enhance the directors' ability to make informed decisions.
Don't Forget about Contractual Duties
In addition, officers and often employees may have contractual duties that exceed these common law duties. These duties could include employment responsibilities and performance standards in employment agreements, restrictive covenants in noncompetition agreements, secrecy requirements in confidentiality agreements, and disclosure requirements in expense reimbursement agreements. These duties can also include those responsibilities set forth in employment policies that are incorporated as part of the employment agreements.
The Negligence Standard
Officers and employees are generally held to a negligence standard of culpability based upon a prudent person in like position under similar circumstances. Although a director's duty of care is similarly based upon a prudent person in like position under similar circumstances, directors are afforded the protection of the so called "business judgment rule." Under this rule, courts do not question the wisdom of directors' decisions unless there is proof of a breach of fiduciary duties, such as fraud, bad faith, or abuse of discretion. Therefore, directors are not liable for a business decision simply because it proves to be bad. This protection is not routinely afforded officers or employees.
The Standard of Proof
Most states require, as a standard of proof, a preponderance of the evidence to show negligence by an officer or employee (i.e., a showing that more likely than not a breach of duty or misconduct occurred). This is a lesser standard of proof than for actions against directors in some states which may require clear and convincing evidence that a breach of duty or misconduct occurred.
Indemnification
Under most states' laws, corporations may indemnify, or agree to indemnify, directors and officers against liabilities, and directors and officers may in certain circumstances be entitled to indemnification. However, in most states there are limits on indemnification. For example, in most states indemnification is precluded if a court finds a director did not act in good faith or in a manner reasonably believed to be in the best interests of the corporation. Some states preclude indemnification in a derivative action if the liability involves negligence or misconduct by the director in the performance of a duty to the corporation.
D&O Insurance
For officers, errors and omissions insurance is important. Most states' laws do not prohibit insurance giving broader coverage of officer liability than permitted by indemnification. By reviewing and comparing coverages of the insurance products of different insurers, officers can usually find this broader coverage at reasonable rates. There are many reasons why senior management, as well as directors, should have the protection of D&O insurance including:
Most states' laws permit broader protection by insurance than by corporate indemnification.
Insurance will provide greater protection in derivative actions brought by or in the name of the corporation.
The Securities and Exchange Commission has not found D&O insurance protection of directors, officers, employees, and agents of a corporation to be against public policy as it has found indemnification for registration and disclosure violations under federal securities laws.
Unless protection is provided by D&O insurance or separate contract protecting a director, officer, employee, or other agent of the corporation, indemnification under most states' statutes is left to the discretion of others and there can be no assurance that indemnification will in fact be made available. If not funded by D&O insurance, there can be no assurance that the corporation will have sufficient assets or other financial means to pay anything even if indemnification is permitted and determined appropriate.
Contract, Insurance, and Indemnification Review
Many boards, as well as members of senior management, are not aware that the business judgment rule under most state corporate statutes does not protect officers. Boards and senior management may not be aware that protection may not exist when needed if there is not a separate contractual or D&O insurance protection. Unless their employment agreements otherwise provide, officers are liable for negligence directly to their corporate employers as well as derivatively to their shareholders. Most boards should have an interest in offering senior management protective clauses in their employment agreements, adequate D&O coverage, and express corporate indemnification. We believe that boards would serve the best interests of the corporation as well as the shareholders by authorizing a review of employment agreements, D&O coverage, and corporate indemnification to see if senior management is adequately protected.
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