Directors and Officers Liability Insurance

Drawing of board members sitting at a conference table and voting
Image courtesy of [Katrina Charmatz] / Getty Images.

Directors and officers (D&O) liability insurance protects corporate officers and directors from claims alleging they performed their duties improperly. If your company is a corporation, you should consider purchasing this coverage. Lawsuits against board members and company officers can generate large awards, for which these individuals may be personally liable.

What is a Corporation?

A corporation is a legal entity that is owned by shareholders and governed by a board of directors.

The directors are elected by company shareholders. The board appoints officers who manage the day to day affairs of the company. The officers typically include a president, a chief financial officer, and a secretary. Some companies have additional positions, such as a chief information officer or a chief human resources officer.

Liability

A corporation is vicariously liable for negligent acts or errors committed by directors and officers while performing their duties on the corporation's behalf. Thus, a corporation is subject to suits by third parties for injuries they have sustained as a result of acts committed by a director or officer.

Directors and officers may be sued individually for acts or errors they commit while serving the corporation. These individuals may be held personally liable for such acts. If a director of officer is found liable for a wrongful act, his or her personal assets may be used to pay damages to the plaintiff.

Stockholders are essentially silent owners of a corporation. They have no control over the management of the company. Thus, stockholders cannot be sued as a result of negligence or wrongdoing committed by officers or directors.

Indemnification

One concept that is central to D&O liability insurance is indemnification.

Officers or directors may be sued as a result of acts they commit while serving the corporation. If these individuals had to pay the costs of those suits out of pocket, few people would choose to be corporate officers or directors. Thus, most states permit corporations to indemnify (reimburse) officers and directors for damages and expenses they have incurred due to lawsuits. States may prohibit indemnification under certain circumstances. For instance, companies may be barred from indemnifying directors or officers who have been convicted of certain criminal acts.

Many states allow corporations to decide the extent to which they will indemnify officers and directors. These decisions are often incorporated into a firm's bylaws.

Directors & Officers Insurance

Directors and officers liability (D&O) coverage is a type of errors and omissions insurance. It protects directors and officers from lawsuits filed by shareholders, regulators, state investigators, or other third parties. Companies purchase this coverage in order to attract and retain highly qualified directors and officers.

D&O policies are designed to cover claims based on financial injuries, not bodily injury or property damage.

They cover third-party claims for financial losses sustained due to an error or omission committed by a director or officer. For instance, shareholders sue company officers, claiming that a recent merger was intended to enrich the officers to the detriment of the shareholders. 

Most D&O policies provide the following three types of coverage:

  • Directors and Officers Liability Covers damages and expenses assessed against a director or officer who has not been indemnified for these costs by the corporation. This coverage is often called Side A. It protects directors' and officers' personal assets. A company may be unable to provide indemnification because it is bankrupt. Alternatively, it may be barred from indemnifying a director or officer by law. States generally prohibit indemnification of directors or officers who are the subject of a derivative suit. This term means a suit filed by shareholders on the company's behalf against directors or officers.
  • Indemnification Reimburses the corporation for funds it has paid to directors or officers or on their behalf as indemnification. This coverage is often called Side B.
  • Corporate Liability Covers claims or suits filed directly against the corporation. It is often called Side C or Entity Coverage. The scope of this coverage varies depending on whether the insured company is a private, public or non-profit corporation. If the insured company is a public corporation, entity coverage usually applies only to securities claims.

 D&O policies are claims-made. This means they cover claims made during the policy period. Claims made after the policy expires aren't covered. Many policies include the option to purchase an extended reporting period, which covers claims reported after the policy has expired. Some policies include coverage for employment-related practices like discrimination and wrongful termination. If this coverage isn't included in the policy, the insurer may offer it under a separate employment practices liability form.

Specialized Policies

Many insurers that offer D&O coverage have developed specialized policies for certain types of companies. An example is a Private Company D&O policy, which is designed for corporations whose stock is not publicly traded. Special policies are also available for public companies, healthcare companies, and educational institutions.

Article edited by Marianne Bonner