Shielding Small Businesses:
Why Directors and Officers Insurance is Essential

There are many good reasons to incorporate a business: better access to financing, ease of transferring or selling shares, lower tax rates, and increased credibility. One of the most critical reasons is that incorporation reduces the liability for the individuals who decide the business’s direction and activities.

The company’s articles of incorporation include an indemnification clause that shifts responsibility to the business for any hurt, loss, or damage caused by directors to the extent permitted by law. But transferring the liability to the business may not absolve directors or officers entirely; they can still be found negligent. And the business may be required to defend the actions of directors and officers in court; if unsuccessful, it may have to pay compensation and legal fees. The resultant financial hit to the business can have a substantial impact on the company’s future viability, and the equity of shareholders, directors, and officers.

The actions of corporations and their representatives have become increasingly subject to public scrutiny and reputational risk. Standards of what’s acceptable business conduct are shifting, and businesses face a heightened prospect of liability and litigation. Claims may be brought in relation to:

• Employee health and safety legislation breaches, failure to comply with workplace laws, discrimination or other inappropriate practices or behaviour
• Theft of intellectual property.
• Lack of corporate governance or acts of “bad faith” committed by directors or officers resulting in financial losses or bankruptcy.
• Misrepresentation of the company’s financial and human resource assets.
• Mismanaged funds, reporting errors, or a breach of fiduciary duty in buying or selling company assets or securities.

To manage this risk, your insurance broker will recommend Directors and Officers (D&O) Liability insurance, also known as Management Liability insurance. It protects the personal assets of corporate directors and officers, and their spouses, if they are sued because of decisions and actions taken as part of their regular duties. A claim on a D&O insurance policy would pay the losses associated with monetary demands – for example, defence costs, settlements, or even fines for wrongful acts committed by directors and officers.

Within a D&O insurance policy are three insuring agreements; a typical policy includes all of these, known as ABC coverage:

• Side A, Non-indemnifiable Loss, covers directors, officers, and sometimes employees, for defense costs, settlement fees, or judgements if the company cannot or will not indemnify them. For example, the company may disagree with the need to indemnify, may be legally precluded from doing so, or may not have the financial resources to do so.
• Side B, Indemnifiable Loss, reimburses a company for its indemnification obligation to its directors and officers. It covers a business when it must pay defense costs and legal settlements for directors and officers. Side B responds to the majority of claims brought against directors and officers.
• Side C, Entity Coverage, helps when a business is named in a lawsuit along with directors and officers. This coverage protects a business when there are direct claims made against it. Coverage is usually for current, future, and past directors and officers of a company and its subsidiaries. D&O insurance covers the individual for acts performed or omitted while in that position with the company during the policy period.

D&O insurance coverage is purchased in excess layers, or towers. The primary layer provides a basic limit; subsequent layers may require additional insurers to share the risk. A Side A Difference in Conditions policy provides excess Side A coverage; it fills in gaps in a company’s D&O tower when any underlying insurer fails or refuses to pay, attempts to rescind coverage, or becomes insolvent. Extensions to the D&O policy can be purchased for specific risks such as employment practices liability, pension trustee liability, or employee fidelity.

As with all insurance contracts, some risks are excluded from the D&O policy. It does not cover deliberately fraudulent or criminal actions, claims arising from directors or officers receiving illegal remuneration or personal profit, claims made under a previous policy, or claims for fines or penalties that are uninsurable by law.

The cost of D&O insurance is based on a variety of factors, including the type and size of the business, the details of the coverage, and whether the company has had prior legal claims.

It’s a common misconception that only large private and public companies with boards of directors need D&O liability insurance. Not so. Small businesses face the same risks and exposures and proportionately, may have more to lose.
The risks can come from outside the business or from within. The D&O policy may be the lifeline that saves the company from an existential blow.

Directors and Officers Liability coverage is complex and determining coverage requires a thorough risk analysis. How much coverage is enough? What and who is covered – and what is not? How can risks be mitigated?

This is where an insurance broker’s advice is invaluable.