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Posts Tagged ‘Closely held private companies’

Private Companies need D&O coverage also

Tuesday, August 25th, 2009

Closely held private companies often wonder why they might ever need directors and officers liability coverage.  Unfortunately the typical scenario in which opinions change is when a company and its officers and/or directors find themselves facing mounting defense costs in such a case.  Better to examine the real exposure ahead of time we feel. Here is an article that that I think  may help to start the dialogue. Please feel free to contact us if you have questions or want to pursue coverage options.

Tom Bryant is a partner in Meridian Consulting. His 35 year work career began in a farming community in Alberta and encompasses years in the onshore/offshore oilfield industry, penitentiary and parole supervision of violent offenders in the Correctional Service of Canada, and more recently risk management for corporate clientele primarily in the energy industry.

Private Companies Need D&O Insurance, Too

By Shannon A. Graving and Thomas H. Bentz Jr.

Directors’ and officers’ policies aren’t just for public corporations. D&O protection can save

owners of a closely held business from bankruptcy in the event of a lawsuit against the company.

Owners of many private companies, particularly those that are closely held by relatives, believe they have no need for

directors’ and officers’ (D&O) insurance. Unfortunately, they may learn a costly lesson when they incur defense costs or,

worse, pay settlement amounts or judgments. Private companies may be subject to claims from a number of plaintiffs for a

variety of reasons.

When a family’s assets are tied up in a single company, uninsured loss is a serious concern. Consider this: When directors

and officers are sued, their first line of protection for their personal assets is indemnification from the company. When those

same directors and officers own the company, indemnification essentially comes from their own pockets. Depending on the

size of the claim and the depth of their pockets, a lack of insurance to reimburse the company could result in bankruptcy.

Therefore, private companies must have broad D&O insurance protection. In fact, you should think of it as a part of your

estate planning; otherwise, there may be little to pass on to the next generation.

Many plaintiffs, many causes of action

Most people think of shareholder suits when they think of D&O insurance claims. As discussed below, that is a risk, even for

private companies, but it is not the only one. Lawsuits may be brought by employees, competitors, customers, creditors,

investors, government agencies and vendors for such causes of action as fraud, unfair competition, interference with

prospective economic advantage, wrongful interference with a contract, infringement of trade secrets, breach of contract and

violations of various regulations.

The most common suits against private companies are employment practices liability claims. In its 2007 Directors and

Officers Liability Survey, Towers Perrin reported that 43% of all claims against private companies in 2007 were made by

employees. Many D&O insurance policies for private companies include employment practices liability insurance, which

covers claims from employees (including potential and former employees) alleging a myriad of wrongful acts, such as

discrimination, harassment and wrongful termination.

The next category of frequently filed claims consists of those by shareholders. Towers Perrin’s 2007 Directors and Officers

Liability Survey found that 32% of all claims against private companies in 2007 were made by shareholders. Directors and

officers at private companies owe the same fiduciary duties to their shareholders as do those who serve public companies.

Disputes may erupt even if shareholders are friends or relatives of the company’s directors and officers. Since private

companies may not follow the same rigorous procedures as their public counterparts and are more likely to contract with

affiliated businesses, there may be more room for questioning whether management complied with its fiduciary duties and

acted with due authority.

It is important to note that a company can be subject to securities laws on the federal and state level even if its shares are not

traded on an exchange or over the counter. Private companies are at risk for a number of securities-related claims, such as for

errors or omissions in private placement materials.

Transactional risks

Significant corporate transactions, such as a sale, acquisition, merger or initial public offering, increase the risk of a claim

dramatically. Some family members may believe the company should be sold for top dollar, while others may feel that the

value in keeping the family business exceeds the proposed purchase price. Whoever loses the argument may sue the company

and its directors for breach of the duty of care or loyalty.

Another possibility is that employees and third parties may disapprove of the deal and bring suit. A transaction can even

trigger the filing of latent claims. For instance, an employee who is the subject of harassment may take no action out of a

sense of loyalty to the company. Once the owners decide to sell, the employee may feel the company is no longer loyal in

return and decide to file suit.

In the case of an IPO, decisions and actions that may be the subject of claims are often made far in advance of the IPO

effective date. If a company is considering going public in the foreseeable future, it is particularly important that it purchase

D&O insurance immediately in order to provide coverage of all pre-IPO decisions and activities.

Obtaining broad coverage

Simply purchasing a D&O insurance policy is not enough. There are a number of steps you should take in order to obtain the

best protection for your assets.

1. Arm yourself with information.

your company. Do not just compare premiums. Each D&O insurance policy is unique, with its own virtues and flaws. Be sure

to ask for a comparison of key terms such as the insuring clauses, the definition of “claim” and the exclusions. Understand

what is covered. It may be helpful to pose possible claim scenarios and ask whether you would be covered. For instance,

what happens to your coverage if your company declares bankruptcy?

Once you have engaged a broker, he or she will obtain a number of premium quotes for

2. Request an independent expert review.

work with potential underwriters to obtain quotes and can advise on terms and conditions. However, you should also request

an independent review by an attorney who specializes in D&O insurance to ensure that the company’s program provides the

best coverage available. Such an attorney should be highly experienced — he or she should review dozens of policies each

year and advise on claims, not simply answer a few questions as an adjunct to his or her main practice.

An independent expert review should be requested annually. Market conditions change from year to year. In addition, new

policy forms may be available because of new insurers entering the market and existing insurers offering new policies and

endorsements. As a result, if your company renews its policies without the benefit of a fresh review, you most certainly will

not have the best protection or be able to obtain maximum value for your insurance dollars.

Your broker will be able to provide invaluable information about limits, will

3. Be vigilant about coverage.

comply with the notice and cooperation provisions in their policies. Providing notice is often not the first concern when there

is a lawsuit, but if your company does not provide prompt notice, you risk losing coverage. The same is true if your company

does not comply with the cooperation requirements. Whenever a claim is made, it is in your interest to ask if your D&O

insurance policies have been consulted, whether the applicable insurers have been notified and if someone is responsible for

complying with policy conditions.

Negotiating the best policy will not ensure payment of covered loss. Companies must also

The bottom line

There are multiple potential plaintiffs who may file claims against private companies for a variety of reasons. In order to

protect your assets, it is advisable to purchase D&O insurance. It is not enough to simply purchase any policy. You and your

company should take the steps described above. Otherwise, your family’s assets may be unnecessarily at risk.

This article appeared in “Family Business” Magazine, Winter 2009. Shannon A. Graving and Thomas H. Bentz Jr. are

attorneys at the law firm of Holland & Knight LLP. They specialize in D&O and management liability insurance, with a

focus on D&O policy negotiation and coverage counseling (