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Know the Law: Private Companies Need to Protect Directors and Officers from Liability

Published in the Union Leader (10/27/2019)

Question: Does my private company need to worry about directors and officers indemnification and insurance?

Answer: In a word, yes.

Corporations often provide indemnification to their directors and officers (and many directors and officers expect such indemnification) for liabilities they may incur in their capacity as directors and officers.

For many corporations (whether public, private, or nonprofit), indemnification of directors and officers (D&O) is crucial to the corporation’s ability to attract and retain well qualified executives, who otherwise might be reluctant to serve without the ability to mitigate their personal exposure to litigation risk.

Although (D&O) indemnification and insurance are frequently discussed in the context of blockbuster public corporation shareholder litigation, such discussions do a disservice to private corporations by overlooking other sources of potential litigation exposure that may be more relevant (and existentially threatening) to a private corporation.

In addition to shareholder suits, D&O claims can be brought by employees (e.g. harassment, discrimination, wrongful termination), lenders (e.g. inaccurate disclosure or financial reporting), customers (e.g. misleading statements, false advertising), vendors (e.g. contract disputes), competitors (e.g. unfair competition, infringement of rights), the government (e.g. violations of environmental or health and safety standards) and other third parties.

Indeed, private corporations arguably may be more exposed to these claims because the directors and officers of a private corporation are typically more involved in day-to-day operations and decisions than their public corporation counterparts. In closely held private corporations, D&O claims can also arise from management and succession disputes.

Equally as important as D&O indemnification is D&O insurance. According to a 2016 report, 1 in 4 private companies experienced D&O losses within the past three years, with an average reported loss of $387,000 (and a maximum reported loss of a staggering $17 million). Importantly, D&O insurance protects more than just directors and officers — it can protect the corporation as well.

There are three common types of D&O coverage:

Coverage for directors and officers for personal loss resulting from conduct arising out of their duties (“Side A” coverage).

Reimbursement to the corporation for indemnifying directors and officers (“Side B” coverage).

Reimbursement to the corporation for claims made directly against it (“Side C” “entity coverage”).

Coverage options may be different for private and public corporations, reflecting the different circumstances and needs between the two. For example, “Side C” entity coverage for private corporations is often broader than for public corporations (which typically includes only securities claims). Your attorney can help you draft a D&O indemnification policy and select a D&O insurance policy that fits your needs.

Bill can be reached at [email protected].

Know the Law is a bi-weekly column sponsored by McLane Middleton, Professional Association. We invite your questions of business law. Questions and ideas for future columns should be addressed to: McLane Middleton, 900 Elm St., Manchester, NH 03101 or emailed to [email protected]. Know the Law provides general legal information, not legal advice. We recommend that you consult a lawyer for guidance specific to your particular situation.

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