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Directors & Officers Liability Insurance is a necessity for a publicly held corporation. The risk is simple to understand: if the price of the company’s stock drops too much or too fast, lawsuits will follow. But privately held and non-profit companies do not face that risk, because they don’t have a stock listing that plaintiff attorneys can follow.
So why do such companies buy D&O Insurance? Here are the top six reasons:
1. The Board of Directors Will Want It. Directors and officers can sometimes be held responsible for the acts of the company, particularly if they fail to honor their fiduciary duties (Duty of Care, Duty Loyalty, Duty of Obedience). Without sufficient insurance coverage, their personal assets are at risk.
2. Shareholder Are Not the Only Source of Claims. Even companies without any outside investors are at risk of a claim. Overall, a greater percentage of claims come from other places – vendors, lenders, customers, regulators, employees, competitors, activists – than come from shareholders.
3. The Indemnification May Not Be There. A company’s charter will nearly always promise to indemnify the directors and officers for whatever claims may arise in conjunction with their service to the company. But if the company is insolvent, the indemnification obligation will take a back seat to the claims of bankruptcy attorneys, secured creditors, and others higher in priority.
4. General Liability Policies Do Not Cover Pure Financial Loss. A General Liability policy covers bodily injury and property damage, but will not protect the managers for claims that arise out of mismanagement that leads to financial loss only.
5. Professional Liability Policies Do Not Cover Executive Errors. Some organizations purchase Profession Liability for financial losses due to errors in their professional services. These policies will not protect the managers for mistakes made in the overall management of an organization unrelated to a service provided for a fee.
6. Defense Costs are High. Even if a lawsuit is groundless and spurious, the defense costs to resolve the dispute can be very high. Defense costs are included in a Directors & Officers Liability policy, and for many claims, the defense costs end up exceeding the amount paid in settlement.
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