Skip to Main Content

Helping Family Businesses
Prosper Across Generations®

Do We Need D&O Insurance

Dear Advisor:

As we upgrade our board of directors, several questions have come up. Do most family owned businesses with outside directors have D&O insurance? Is the liability for directors and officers in family owned businesses increasing or decreasing? Is there something we can add to our by-laws or charter or somewhere that would greatly minimize the liability for our directors to the point where insurance isn’t necessary?

 


Director liability has received renewed attention in the recent past due to the corporate governance issues that have surfaced in the public company sector. As is often the case, the ramifications of these public sector issues has had an impact on closely held family owned businesses.

The perspective I will share with you in responding to your questions will be based on my experience as a director with several family businesses, my and the Family Business Consulting Group’s experience in helping family businesses to establish effective outside boards and my experience as a former chairman and CEO of both privately held and public companies.

D & O Insurance

The National Association of Corporate Directors (www.nacdonline.org) has conducted several surveys of both private and public companies and has found that the majority of such businesses carry Directors and Officers Liability Insurance. My experience with family businesses suggests that larger companies (over $50 million in sales for example) have some form of D&O insurance. Smaller companies tend not to have such insurance, based primarily on cost factors. However, companies in environmentally sensitive industries or companies subject to higher risk due to safety or consumer liability issues will tend to be more receptive to D&O premium expenditures. Two-thirds of the boards I serve on have D&O insurance. All of them have some form of indemnity in their by-laws to protect directors.

How Much Liability?

In my discussions with attorneys familiar with director liability, I have been advised that it is very difficult to prove liability on behalf of independent directors who have been diligent in their duties. Having said that, my sense is that while actual liability may not have increased significantly, sensitivity of individual directors to potential liability has. If the board is managed professionally and is diligent in its required functions and oversight, individual liability should not be a compelling issue. That places a premium on making sure that the board functions properly. Directors should be much more diligent in their roles on audit committees, their review of safety and security policies and procedures and the accurate representation of company performance to stakeholders. If the company has exposure to potential shareholder conflict, if the company has had prior legal or safety issues, or if the company’s financial position is suspect, directors will be well advised to increase their level of diligence and oversight.

Is Insurance Necessary?

The financial implications of liability can be tempered by insurance or by the company agreeing to defend and compensation directors through provisions made in the by-laws. When accomplished through by-law provision, the company generally will make a commitment to defend directors against legal actions brought against them due to their positions on the board and if found liable, reimburse the directors for financial loss. The normal exception to this protection involves intentional misconduct by the director. The degree of comfort given by such protection by the company will depend on the financial strength of the company. Many companies provide both by-law protection and D & O insurance coverage. Many smaller companies provide only by-law protection due to the cost of D&O insurance. As D & O premiums increase, which has been the case recently, I have seen more attention place on by-law support.

When considering D & O insurance, be careful to understand the differing forms of coverage and exclusions. Make sure you understand exactly what is covered and what is not. The mere fact that a company has a D & O policy can convey a false sense of security if the terms and exclusions within the policy are overly restrictive. Make sure you get an understandable explanation of the policy before you buy.

I hope this gives you some help in dealing with this very difficult but important issue for your board.

 

Back

 

Articles purchased or downloaded from Family Business Consulting Group® are designed to provide general information and are not intended to provide specific legal, accounting, tax or other professional advice. Since your individual situation may present special circumstances or complexities not addressed in this article and laws and regulations may change, you should consult your professional advisors for assistance with respect to any matter discussed in this article. Family Business Consulting Group®, its editors and contributors shall have no responsibility for any actions or inactions made in reliance upon information contained in this article. Articles are based on experience on real family businesses. However, names and other identifying characteristics may be changed to protect privacy.

The copyright on this article is held by Family Business Consulting Group®. All rights reserved.
Articles may be available for reprint with permission. To learn more about using articles for your publication, contact editor@thefbcg.com.

8770 W. Bryn Mawr Ave., Ste 1340W, Chicago, IL 60631
P: 773.604.5005 E: info@thefbcg.com 

© 2017 The Family Business Consulting Group, Inc. All Rights Reserved.

close (X)