Do Private Company Directors Need Insurance?
By Maureen Milford
Randall W. Larrimore, a highly qualified corporate director and former CEO of a $4 billion company, agreed to join the board of Nixon Medical because he felt an obligation to “give back” to a small company in his home state of Delaware.
Larrimore chose to serve on the board of the private medical apparel and linen company that has approximately $65 million in annual sales despite his compensation being just 8% of what he’s paid by each of his board memberships at Campbell Soup Co. and Olin Corp. “I certainly am not doing it for the money,” he says of Nixon. But there’s one directorship element Larrimore refuses to cut.
“I would never serve on a private or public company board that didn’t have sufficient D&O (directors’ and officers’) Insurance,” says Larrimore.
Larrimore got no argument from Nixon president Jason Berstein. “For regular conduct, we believe that the corporation should be obligated to protect directors from personal liability,” Berstein says.
D&O insurance protects the personal assets of individual directors and their spouses or domestic partners, as well as their estates, if claims, such as a lawsuit or demand for money, are made against them for actions they took in their capacity as a director. It provides defense costs for litigation and indemnity protection.
“While (private directors) may not serve for the money, they certainly don’t want any personal exposure. There isn’t enough upside for them to take on that risk,” Berstein says.
Still, many executives at private companies where the shares are owned by a small number of people feel they do not need D&O insurance because, unlike publicly held companies, they don’t have outside shareholders, says Kevin LaCroix, an attorney who consults with companies on directors’ and officers’ liability insurance matters.
“If the company is closely held, they think they won’t get hit with a shareholder claim and therefore don’t need D&O. It is true they may not get hit with a shareholder claim but it is not true that they don’t need D&O as there are many other prospective D&O claimants beyond just shareholders,” explains LaCroix, who is Executive Vice President, RT ProExec, an insurance intermediary focused exclusively on management liability issues.
“The fact is that private company D&O claims are frequent and expensive.”
Indeed, a 2018 report by Chubb on risks for private U.S. companies says that 26% of private companies surveyed had experienced a D&O loss during the previous three years. The average loss was just under $400,000. Besides the financial hit, the losses had a negative impact on the company culture and brand reputation, Chubb reports.
Yet just 43% of companies responding to the survey indicated they buy D&O insurance. One-third of the businesses without insurance said they don’t believe they need it because the business is privately held.
“Small or family-owned businesses often report that since ‘everybody loves us,’ they would never be subjected to a lawsuit,” the Chubb report says.
Advisers to private business strongly disagree.
The frequency and severity of employee claims for harassment, discrimination and wrongful termination against the company and directors and officers have been increasing against private companies, according to a 2017 report on private company D&O liability by the National Association of Corporate Directors and Marsh insurance broking and risk management firm.
But customers, clients and consumer groups also make claims alleging harassment, discrimination, violation of civil rights, contract disputes, and false advertising, the NACD report says. Chubb reports that the most D&O losses were related to claims brought by customers.
Competitors and suppliers can allege unfair competition, anti-trust violations or infringement of a trademark or patent. There can also be claims related to environmental contamination to employee health and safety, according to the NACD report.
“Here’s the thing about D&O claims — I have been doing this for 35 years and it is always something new,” LaCroix explains.
And when private companies do have shareholders, investors or bondholders, claims can be brought for such things as disclosure failures in private placement materials or misstatements in financial material, according to the NACD report. Mergers and acquisitions also can give rise to claims, including lawsuits arising from past actions of the acquired company.
“The D&O insurance can and many times prove to be the last line of defense for corporate directors and officers who have been hauled into a claim. This is particularly true in the event of claims arising at a time when the company is insolvent and can’t honor its indemnification obligations,” LaCroix says.
According to LaCroix private company’s can obtain D&O insurance that is quite comprehensive for a reasonable price.
“Because the private company D&O insurance policies provide broad coverage at relatively low cost it should be a part of every private company’s risk management portfolio — not just private companies with a broad ownership base,” LaCroix has written.
Other recommendations from LaCroix and the NACD include:
- Recognize that D&O insurance helps attract and retain top-quality directors.
- Don’t allow small premium differences to drive important insurance decisions, that could leave directors exposed with insufficient protection.
- Perform regular reviews of the D&O insurance. Look to improving the scope of coverage and minimizing exclusions.
- Review the insurance when the legal landscape evolves or the risk profile of the company or board changes.
- Consider increasing limits as the claims environment changes, defense costs rise and potential liability increases.