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Key13 On being sued: directors' liability and insurance

The business judgment rule described earlier provides some protection for directors. But the complexities of corporate life and law mean that directors still may easily end up as defendants in litigation. Even if they emerge victorious, the cost of mounting a legal defense can be prohibitive.

To cover these litigation costs for directors, corporations are authorized to carry what is commonly referred to “D & O” insurance. D is for director and O is for officer and the two letters together man that directors and officers get insurance coverage when they are sued by shareholders for certain types of conduct. The conduct not covered under a D & O policy is covered in Key 14. The conduct covered under a D & O policy includes everything from negligence on the part of directors and officers to violations of environmental laws.

Directors have been sued for the acquisition of a company that later failed as well as the failure to diversify. If the books of a company are cooked, the directors and officers may be sued for the failure to provide adequate internal controls and supervision. In the In re Caremark case, a landmark decision on director liability, the court held that the failure of a board to establish adequate checks and balances for corporate spending and bookkeeping is a breach of a director’s fiduciary duty. Not minding the store is a basis for director liability which is covered under D & O.

D & O insurance is purchased by the company and covers directors, officers and, especially in employment litigation, other employees of the company acting at the direction of officers and directors. The amount of coverage carried depends upon the nature of the company and its line of business. Directors serving on a utility with a nuclear plant simply cannot get too much D & O coverage. Few companies would carry policies for less than $100 million because verdicts and settlements of that size are not at all unusual.

For the most part, D & O insurance protects directors when shareholders challenge a decision. And shareholders have become increasingly active litigators.

Indeed, when Congress passed the Securities Litigation Reform Act in 1998, one of the act’s provisions required that shareholders actually be aware that they have filed a suit before the suit can be filed. Apparently suits were being brought by lawyers who knew D & O coverage would kick in, but these lawyers forgot to notify the plaintiffs they were allegedly representing that they were indeed bringing suit against a corporation in which they held shares. In short, the litigation against directors and officers had gotten a little out of hand. While the new law was intended to curb litigation against directors and officers, its impact has been minimal and D & O insurance is as necessary as ever.

In addition to litigation and liability over corporate decisions directors and officers may find that their greatest exposure lies in employment practices liability (EPL). Claims against companies for employment practices are frequent and costly. Texaco settled a race discrimination charge for over $100 million. So did Shoney’s. State Farm settled an expensive gender discrimination case. As of this writing, Coca-Cola faces a race discrimination class action lawsuit for discrimination in its evaluation process for white–collar workers (Coke has filed a motion to dismiss the case). The size of the settlements in these cases demands high levels of coverage. A $100 million employment practices case can exhaust a company’s D & O coverage.

As a result, many companies now carry a separate EPL policy, or a stand-alone policy. In addition to protection for directors and officers, these EPL policies also provide coverage for the corporation. One expert has noted the carrying only D & O coverage for EPL is like insuring the contents of your house against fire but not the house itself. A separate EPL policy can also include coverage for punitive damages, since some of the awards in such cases could break a bank, let alone a textile company.

A board should review the D & O coverage each year to be certain that the amounts are adequate, that it covers all expected types of risks and that the insurer can be counted on to pay off. There are plenty of off-shore D & O insurers. But if one of them refuses to pay, good luck is trying to enforce your contract. Directors should be certain that they have early coverage, plenty of it, and extensive protection against all kinds of risks.