Executives at companies whose securities are publicly traded typically don’t need to be persuaded that their company needs D&O insurance. They understand that the exposures public companies face make D&O insurance indispensable. However, the view of some private company managers may be different, particularly for officials at companies whose shares are very closely held. These company officials may believe their company has little risk of getting hit with a D&O lawsuit and as a result conclude that they don’t need D&O insurance. However, the reality is that D&O insurance is an indispensable part of every company’s risk management arsenal, whether or not a company’s shares are listed.
Why Private Companies Need D&O Insurance
As discussed in a May 2, 2017 memo from the Pillsbury law firm entitled “Reality Check: Private Companies Need Directors’ and Officers’ Insurance Too” (here), private companies face “increased scrutiny” from a variety of sources and the volume of lawsuits and investigations against private companies “continues to rise” and D&O insurance “provides an invaluable means to cover the ever-increasing costs incurred by companies to combat such actions.”
I frequently run across private company officials who are convinced that because they have only a very small number of shareholders or owners, they will never have a D&O claim and so they don’t need to buy D&O insurance. As the authors of the law firm memo put it, “This business decision may in fact be a mistake.” The list of potential claimants on a private company D&O claim is not limited just to shareholders or owners. D&O claims plaintiffs also could include customers, vendors, suppliers, regulators, creditors and a host of others as well.
The fact is that private company D&O claims are frequent and expensive. As Chubb noted in its 2016 private company risk management survey report, more than a quarter of all companies reported experiencing a claim in the last three years. The average reported loss was $387,000. Among companies responding to the survey that do not buy D&O insurance, the average reported loss was almost $400,000.
Obviously a loss of this magnitude could be devastating for many companies. At the same time, the private company D&O insurance policies available in the marketplace provide broad coverage for a wide variety of kinds of claims at a relatively low cost.
The Broad Scope of Coverage Available
The coverage available under private company D&O insurance policies is materially broader than the coverage afforded under public company D&O insurance policies. The entity coverage available under public company D&O insurance policies generally is limited to securities claims, while private company D&O insurance policies contain no such limitations, meaning that private company D&O insurance policies provide broad balance sheet protection for the insured companies.
An aspect of private company D&O insurance that many prospective buyers often overlook is that the coverage afforded extends far beyond just protection in the event of a lawsuit. As the law firm memo’s authors point out, most private company D&O insurance policies define the term Claim broadly to extend far beyond just lawsuits. The typical definition these days will also define the term claim to mean “a written demand for monetary, nonmonetary or injunctive relief” as well as “a civil, criminal, administrative, regulatory or arbitration proceeding for monetary, nonmonetary, or injunctive relief,” subject to all of the policy’s terms and conditions. This broad wording means that a lawsuit is, as the memo’s authors put it, “only one mechanism by which coverage may be triggered.”
For example, under some policies’ wording, a governmental subpoena or a civil investigative demand may constitute a claim. As the memo authors note, “the potential expense associated with responding to government subpoenas and investigative demands should not be underestimated.” Whether a D&O insurance policy provides protection to respond to subpoenas or governmental investigations is very much dependent on the precise wording of the policy. The wording is subject to negotiation, which is one of the important reasons why, as discussed further below, it is very important for every D&O insurance buyer to enlist the assistance of a knowledgeable and experienced insurance advisor in their insurance purchase transaction.
Aggregate vs. Separate Limits of Liability
In the current D&O insurance environment, private company D&O insurance frequently is offered as one part of a modular management liability insurance policy that combines several management liability insurances in a single combined product. For example, the policy might include not only D&O insurance, but employment practices liability insurance (EPL), fiduciary liability insurance, crime, or even kidnap and ransom insurance. These policies are usually structured with a single declarations page specifying the policy period and the limits of liability, a single policy form specifying terms and conditions common to all coverage, and then separate policy forms for each of the coverage lines in the combined program.
Many buyers will often purchase a program with a single aggregate limit of liability applicable to all lines of coverage, so that a loss on any one line will reduce the limits available for claims arising under other lines of coverage. Purchasing a policy with a single aggregate may entail some cost savings, but it could mean that if multiple claims were to arise triggering more than a single line of coverage, directors and officers might be exposed to continuing claims with reduced or no remaining insurance protection available. While different buyers may reach different buying decisions on this issue because of cost considerations, I have a bias in favor of separate limits for the separate coverages. I believe steps should be taken to ensure that there is a fund of insurance available to protect the individual executives, without concerns that other claims against the company might drain away the insurance.
Private Company D&O Insurance Entity Liability Exclusions
Because the entity coverage protection afforded on private company D&O insurance policies is broader than the securities claim-only entity coverage protection afforded under public company D&O insurance policies, the private company D&O insurance policy typically includes exclusions that are usually not found on the public company D&O insurance policy. For example, the private company D&O insurance policy typically will include an exclusion for entity intellectual property claims. Other common entity exclusions that may be found on private company D&O insurance policies include antitrust and deceptive trade practices exclusion; professional services exclusion; and contractual liability exclusion.
These exclusions potentially could be very significant in the event of a claim and could significantly affect the availability of coverage in many kinds of claim. The fact is that some carriers will under at least some circumstances amend or even remove some of these entity coverage exclusions. For example, some carriers will upon request remove the entity antitrust and deceptive practices exclusion. Others will agree to reword the professional services exclusion or even the contractual liability exclusion in ways that potentially could significantly affect the availability of coverage in the event of a claim.
As part of my day-to-day practice, I am frequently asked to review companies’ D&O insurance policy. I am often surprised to see how frequently the wording of the various entity liability exclusions has not been addressed. To be sure, it may be that in any particular instance, the carrier refused requests to modify the exclusions, but because these exclusions are so often modified, the absence of any modifications may also mean that the exclusions were not modified because the insurance representative that placed the policy failed even to attempt to modify the exclusions.
Securities Offering Exclusion
Yet another private company D&O insurance policy exclusion that can be critically important is the public offering exclusion. Private company D&O insurers do not intend to cover exposures arising from the issuance or subsequent public trading of company securities, so private company D&O insurance policies typically include a public offering exclusion. A particular concern with these kinds of exclusions is that the sometimes are written so broadly that they could preclude coverage arising from pre-IPO activities. If the company is preparing to go public, its senior executives undertake a variety of activities that may create potential liability exposures. If the company does not complete the offering and claims result, the private company D&O insurance policy will be called upon to respond to the claim.
If the securities offering exclusion is written in an overly broad way, it potentially could affect the availability of coverage for these kinds of claims. Some carriers, in an attempt to address this concern, will include a “roadshow coverage carve back” preserving coverage for some types of claims that otherwise would be precluded from coverage under the securities offering exclusion. These wordings, while potentially helpfully for certain kinds of claims, are not sufficient to address all of the potential pre-IPO exposures, because pre-offering problems might arise that have nothing to do with the roadshow.
Conclusion
The bottom line is that every well-advised company — whether publicly traded or privately held — should have D&O insurance. The concerns arising with respect to the entity liability exclusions discussed above as well as with respect to the securities offering exclusions are good illustrations of the fact that for all D&O insurance buyers, including even private company D&O insurance buyers, it is critically important to associate knowledgeable and experienced advisors in the insurance acquisition process. Without the involvement of this kind of expertise, buyers could wind up with D&O insurance coverage that is not well-suited to the company’s needs and exposures – and even worse, could mean that coverage is not available as intended or expected when claims do arise.
Readers interested in knowing more about D&O insurance may want to refer to my series of articles titled “The Nuts and Bolts of D&O insurance,” which can be found here. For more information about the antitrust and deceptive practices exclusion, refer here. For information about the critical importance of the wording of the professional services exclusion and the contractual liability exclusion, refer here. Finally, with respect to pre-IPO claims and questions of D&O insurance coverage, refer here.