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D&O Insurance

What is the Purpose of Directors and Officers (D&O) Liability Insurance?

By January 8, 2022No Comments

What is directors and officer’s liability insurance?

Directors and Liability insurance, also known as D&O insurance policy, offers liability cover for directors and managers of a company. This particular insurance intends to safeguard them from the claims that may arise due to decisions and actions carried out within the scope of their managerial duties. Nowadays D&O insurance has evolved as a regular part of a company’s risk management policy.

The insurance usually covers legal fees, settlements and other costs. Apart from the director or the manager, it also provides coverage to the company in case of third party conflicts.

Companies buy D&O cover because managers can make mistakes. D&O coverage includes monetary protection for directors and managers against the consequences of alleged wrongful deeds. Not only personal liability of the directors and managers of the company are covered, but also the reimbursement of the insured company in case of the claim of the third party on behalf of its managers in order to protect them.

The coverage provided to the directors and officers does not include fraudulent, criminal or intentional noncompliance acts. It does not include the cases where the directors obtained any kind of illegal remuneration or acted for personal profit.

However, Directors and Officers are sued for several other reasons associated with their managerial role that includes:

  • Misrepresentation of the asset of the company
  • Leading fraudulent activities in the company
  • Mishandling of company’s funds
  • Breach of fiduciary duty that might result in financial loss to the company
  • Any activity that might position the company as bankrupt.
  • Lack of corporate governance
  • Failing to comply with workplace laws
  • Theft of intellectual property

Purpose of D&O liability insurance

Undoubtedly Directors and officers liability insurance has become a mandate in any company, to safeguard its interest. However, Let’s dive a bit deeper to understand the purpose behind directors and officers liability insurance in a company. 

  • Provide Legal Cost Coverage
  • Attract Potential Investors
  • Bankruptcy Protection
  • Cyber Breaches D&O Liability Coverage
  • Attract Better Talent

Directors and officers carry a reasonable deal of power and responsibility, along with themselves. They approve crucial decisions that influence operations, finance, personnel, and other departments. This exposes them to a different set of litigation risks. Lawsuits brought against directors and officers can vary. It may be ranging from smaller claims that are brought by dissatisfied employees to large securities class action claims by the company’s shareholders.

For example, if third parties, partners, or investors allege that the company’s board members used the company funds inappropriately, committed errors and omissions, or misrepresented company assets intentionally. In such scenarios, the board members are held personally liable, even if they acted on behalf of the company. 

Likewise, if the organization proposes a benefit package to its employees, the leadership comes under a fiduciary obligation to manage it as proficiently as it could. In case employees or government agencies acknowledge that this is not the case, they will have grounds for a lawsuit. 

Private companies are also subjected to government regulation. A government enforcement action carried against a company or management team can be an extremely high-priced proposition. It can also lead to formal legal action from government and private entities. If the government or independent agencies discover that the company is failing to comply with workplace laws or is unable to determine proper corporate governance within, it can face regulatory actions and penalties.

However, with the right D&O coverage right in place, these types of problems can be settled relatively quickly and routinely. The insurance provider will respond and help to deal with the lawsuit. It will hire the best defense team, and also cover all the expenses.

Attract Potential Investors

Companies with plans to prosper and expand, might need external sources of funding. However, investors will prefer to dominate and safeguard their investment. In simple words it means that they will naturally demand a seat on the board of directors. To reduce their risk and possible exposure to lawsuits, investors will not only favor companies that have a good D&O insurance policy but might actually consider it a requirement. 

Most startup funding agreements from institutional investors will generally specify that a D&O insurance policy needs to be bought within 90 days of closure of the financing.

Bankruptcy Protection

If the company files for bankruptcy, with the D&O policy in place, it might help the company to sail through the financial turbulence in a better way.

Even though bankruptcy relieves the company with an extent of relaxation and protection from litigation, it may put its directors and officers at risk. Some parties might accuse the company’s leadership and their decisions for bankruptcy. They might also demand them to repay the company’s debts and obligations at a personal level.

However, if the directors and officers of a bankrupt company are sued, either individually or all together, they may land themselves in a difficult situation, as the company can no longer indemnify them and help to protect themselves. A good D&O policy will act as a saviour in such situations and provide the executives and directors with protection.

Cyber Breaches D&O Liability Coverage

Cyber breaches are an ever-growing threat, and their overall cost can shake the financial wall of companies or third parties.

The question of who is accountable for the breach and its consequence is complicated. However, what is obvious is the expectations of customers and investors. They will naturally expect the companies and those who operate it, to ensure that sufficient cybersecurity measures are carried out.

But, if the affected parties somehow presume that the top management didn’t do everything in its capacity to mitigate cyber risks and safeguard its systems, they will hold the directors and officers personally liable for damages incurred.

The purpose of D&O insurance here is to provide indemnification to the directors and safeguard their personal liability from being at stake.

Attract Better Talent

Companies are endlessly pursuing top leadership talent of other companies to operate their businesses. However, the market for quality resources is highly competitive. Top-tier managers and officers will not consider joining any such company where their personal assets could be put at risk. 

This indicates that any company seeking to attract validated, high-level managers and board members should consider investing in D&O coverage. After all, insurance against worry is not yet in the market. But D&O insurance can reduce the risk and give the directors and officers the peace of mind needed to go about their work and lead at a high level.

With so much responsibility laying on the shoulders of the management, directors can become overwhelmed with evading the adverse outcomes of their decisions. D&O insurance enables the management to concentrate on making the best possible decisions for the company, instead of distressing about the risks associated with their role.

To conclude, Directors and Officers insurance is a great financial tool for curtailing risk and enabling the directors and officers to have peace of mind. After all only a sane mind can confidently make the needed, sometimes difficult decisions that are critical to spark growth and development within the company. It also enhances financial planning by eliminating the fear that the company will need a reserve of funds to combat potential litigation.

PlanCover.com an insurance broker licensed by IRDAI has been supporting technology startups, small and medium businesses, not for profit companies and large companies with tailor made D&O liability insurances. The expertise gained by having worked on hundreds of liability insurance programs has helped them to simplify the purchasing process by exploring the whole market  and help you make the right choice.

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