Private Business Owners: Why An Outside Board, Why D&O Insurance?

Why should privately owned businesses purchase Executive Liability insurance, specifically Directors & Officers (D&O) Liability insurance? Why should a private business consider establishing an outside Board of Directors and/or Advisors? These questions and issues are relevant to any business that has its eyes on its future and towards remaining both competitive and competent in the business climate of tomorrow.

Why should you consider establishing an outside Board of Directors? Several reasons are paramount, namely: 1) to obtain a variety of inputs and insight from knowledgeable and trustworthy people; 2) to bring suitable expertise and influence otherwise not internally present. Businesses engage legal, accounting and insurance expertise as a routine course of business. By establishing a Board of Directors and/or Board of Advisors, a business can bring assistance and honest scrutiny inside its circle with people who will help the business to become more competent and effective, more proactive and less reactive to challenges. Oftentimes, these people are trusted advisors from the disciplines of the legal, accounting and insurance fields, and their perspective can add leverage to the management of the company from within.

The businesses that recognize these benefits are ready to face and address the questions that their competition may not. Reasons why some companies do not adopt a board might include the following: 1) They think they can do a better job by themselves, as they have for the past so many years; 2) They don’t want anyone to know their compensation and business methods (or lack thereof); 3) They are doing so well they don’t want anyone to find out. In today’s business climate, the challenges that face family-owned businesses are tremendous both outside and inside the walls. The role of a board should be to offer assistance and resources that magnify the strengths and minimize the weaknesses and threats the business faces.

With the adoption and/or presence of a Board of Directors/Advisors, the element of liability is heightened. The duties of the directors and officers are the following: 1) to have a Duty of Diligence, also called Duty of Care, to act in good faith and be consistent with what a “reasonably prudent person would do” in similar circumstances; 2) to have a Duty of Loyalty, also called “disinterestedness,” to refrain from engaging in conduct that could take advantage of the corporation; 3) to have a Duty of Obedience, to adhere to the corporate charter and applicable statutes, and refrain from any illegal or improper activity that could cause ill repute to the director/officer or corporation.

D&O insurance is primarily needed to protect the directors and officers from their liability regarding their decisions, management and oversight of the corporation. Because the company’s General Liability and/or Umbrella Liability policies routinely exclude protection of these areas, the personal assets of these Ds and Os are at risk in the event of a suit. Most of the time, those who are willing to serve on a board are aware of their risks, particularly when reading the bylaws of the corporation that (should) explain the indemnification provisions in the event that a director or officer is sued. The bottom line here is that the company is pledging to protect and indemnify the person, but the protection (read: money and legal fees) is from the company coffers. D&O insurance serves as the “teeth” to this indemnification provision. Why use company money for this benevolent function and peace of mind for the directors and officers when you can transfer this risk via a modest premium for insurance? Another element that should be captured here is that these policies should also be written to include the company or entity as a Named Insured in order to protect the company as well.

Another facet of this insurance that I believe is not properly illuminated is the Duty to Defend provision. In short, in the event of a lawsuit against a company and its management, there are typically many allegations made, some that might not be excluded within an insurance policy, some that might. Most states require insurance companies to defend the insured when at least one allegation is covered by the policy. This is the peace of mind provided to the company and its directors and officers whereby the legal costs and defense are handled by the insurance company even if the opinion from the company is that the suit is meritless and groundless, but would nonetheless be an aggravation, distraction and expense.

Many privately owned businesses want to remain private in every element, and they understand that having an insurance policy means that they are allowing someone else to tell them how the legal defense will be handled. This is no longer absolutely the case, as many insurers will negotiate allowing the preferred legal representation from the insured.

The publicly traded companies have been feeling the heat from the imposition of the Sarbanes-Oxley Act requiring greater accountability and scrutiny from management relative to financial statements and the like. In fact, a recent survey conducted by a large national D&O insurance carrier among executives of insured private companies showed that 30 percent of these executives had either implemented or planned to implement some aspects of the Sarbanes-Oxley Act in their companies. This “sharpening of the axe” has caused something of a ripple effect, affecting privately owned businesses, and an expectation of proper accountability and responsibility from the public and the courts. With the purchase of Directors and Officers Liability insurance, a company that is progressive and tuned to the future can concentrate on its business and let the protection create the peace of mind and pre-funded response in the event it is needed. This increase in the demand/need for coverage coupled with an increase in supply and availability from respectable carriers has enabled private business to purchase and negotiate better terms and pricing than ever before.