Purchasing D&O Insurance: What Family Owned Businesses Need to Know

One of the insurance policies every business should strongly consider having is directors and officers insurance.  Regularly referred to as “D&O insurance”, this is an insurance policy covering directors and officers for claims made against them while serving on a board of directors or as an officer of a company.  These claims can arise in a number of scenarios depending on the type of D&O insurance policy a business purchases.  A true third party could sue the company on some commercial grounds and name some of the directors or officers.  A shareholder could sue the directors and officers of the company, claiming they have been oppressed or mistreated as a minority shareholder.  A shareholder could also sue directors and officers derivatively, i.e., on behalf of the corporation.

As with many insurance policies, a D&O policy comes with numerous exclusions.  And, while many of these exclusions are expected, there is one that comes as a surprise to many family owned businesses: D&O insurance policies frequently exclude claims brought by family members.

This exclusion can present an enormous challenge to a family owned business.  If all of your shareholders are family members, this exclusion effectively excludes coverage for any shareholder claim – which is one of the biggest risks facing closely-held companies.

Why would insurance carriers have this exclusion?  The reasons are fairly simple:  of course insurers are trying to avoid being pulled into family in-fighting over control of the business, but they are also reasonably trying to avoid cooperative collusion.  In a normal corporate setting, one might be particularly skeptical of a D&O claim made by a minority shareholder who happens to be the brother of the director or officer who is being accused.  Of course, it is no guarantee that the brothers have hatched a scheme to make some kind of D&O claim, settle the claim for an award of damages, have their insurance carrier pay out its limits to fund the claim, and then split the money and retire to an island somewhere.  But if you are an insurance carrier, it is certainly easier to exclude these rare kinds of claims from the beginning, rather than to have to be on the lookout for (and then have to prove) collusion of this kind after a claim is brought.

For a normal corporate scenario, this may be perfectly reasonable.  Chances are that no family member shareholders exist and, if they do, there are so few of them or the odds of a claim are so slim that no one gives much thought to the exclusion.

But in a family owned business, family members can frequently make up the entire shareholder base.  So, this kind of exclusion severely diminishes the value of the insurance.  Yet, many family owned businesses have this exclusion in place and only learn about it at the time a claim is denied by the insurer.

D&O policy language and coverage offerings can vary greatly; so review your policy carefully or seek insurance expertise.  Raise this point with your insurance broker so that he or she can seek out and price the different solutions for your business to consider.  Paying premiums and not having any effective coverage is not good for your business; finding out you do not actually have the coverage only after a claim is actually made can be devastating.