Is D&O Insurance a Good Idea for a Family Business?

Directors and officers (D&O) insurance is intended to protect the directors and officers of a business against personal losses they may suffer as a result of a lawsuit against them. The losses incurred may come in the form of legal fees, settlements, or awards of damages paid pursuant to a court judgment.

It is important to understand that D&O insurance covers only those claims made against the individual in their capacity as a director or officer—if someone is a director or officer of a company and is sued on a claim unrelated to the business, D&O insurance will not cover that claim.

Anatomy of a D&O Insurance Policy

Most D&O policies are comprised of three distinct parts: Side A, Side B, and Side C.

• Side A coverage protects directors and officers from certain claims for which the company cannot indemnify them.
• Side B coverage reimburses companies for the amounts that they pay to their directors and officers for certain claims for which the company has indemnified the officers and directors.
• Side C covers certain claims paid by the corporation as a distinct legal entity, but only when it is sued alongside its directors and officers.

Side A coverage is usually not subject to a deductible, while Sides B and C are. It is important to know up front what those "certain" claims are and what they do not include.

It is also crucial to understand that under nearly every D&O policy, all insureds have a shared coverage limit. Even though the policy covers all of a company's directors and officers, if a suit against just one director or officer requires the insurance company to pay out its limits, the other officers and directors at the company will not be able to receive any money under the policy until the term renews—if it does.

One way that directors and officers can protect themselves from the consequences of a judgment against another director or officer that maxes out their plan's coverage is to purchase their own Side A coverage. Many insurers offer policies that include only Side A coverage, intended for purchase by individuals to further protect themselves.

Some companies may even opt to finance individual Side A coverage for their directors and officers in lieu of purchasing a more comprehensive plan. This alternative, however, does not come without expense to the company.

Exceptions and Exclusions to D&O Insurance

There are a number of types of claims that D&O insurance does not cover. The first of those, and perhaps the most important to family businesses, is that most policies exclude claims brought by family members, whether or not they are also a director or officer.

Often, all or most shareholders of a family business are other family members, which means that this exclusion would bar coverage for all shareholder claims. This exclusion is thought to reduce the chance that insurance companies are defrauded through collusion among insured parties. Whatever the rationale, it is an important exclusion to be aware of.

Another category of claims generally excluded from D&O coverage are those made by directors or officers against another director or officer of the same company. In other words, most D&O policies do not cover claims between two parties insured under the same policy.

A third important exclusion is known as the "bad conduct" exclusion. Damages that arise from a director or officer's bad conduct such as criminal activity, fraud, securities fraud, ERISA violations, and other such illegal activity, are generally not covered by D&O policies.

There are also a number of other exceptions that come into play less often than those mentioned above but are nonetheless important. These include exclusions for antitrust claims, pollution and environmental claims, and claims of which the insured had knowledge when the policy was purchased. It is vital to understand your policy, and to know up front what claims are covered, and, of course, what claims are subject to exclusions or exemptions.

So What's Next?

The intricacies of D&O insurance extend well beyond what is covered in this article. If you do not have D&O insurance, or you are in the process of renewing your policy, be sure to consult an experienced business insurance professional. You might also consider a visit with your corporate lawyer to discuss potential legal liabilities that are unique to your business.