Managing Risks for Directors and Officers
July 4, 2015
Every decision that directors and officers (D&O) of a company make has the potential to be scrutinised by clients, employees, shareholders and peers. These stakeholders may pursue legal action if they believe a decision adversely affects their best interests. And the stakes are high—directors and officers risk losing their personal assets if they are ever involved in legal action for a decision made in the course of performing their regular duties.
As a business owner, it is vital to have the proper risk management in place so you can attract talented directors and officers to your company. Consider tweaking the following three aspects of your business to boost your D&O risk management strategies
Prior to hiring a new director or officer, review your corporate structure to make sure your practices are sound and secure. Focus your review on the following:
While reviewing your business’ corporate structure, it is also a good time to take a look at the indemnification clauses in your by-laws or articles of association. Offered by many companies, indemnification clauses allow an organisation to compensate a director or officer for losses incurred while defending against a D&O lawsuit. It is important to review your clauses if you have not done so in years because the language may no longer be clear and you may need to revise or add to the language.
The expenses your executives may incur in a D&O lawsuit can be compensated on either a discretionary or mandatory basis. With discretionary indemnification, companies have no obligation to reimburse expenses, although they can do so if they wish. Reimbursement is decided on a case-by-case basis. With mandatory indemnification, businesses are obligated to reimburse all directors and officers for expenses incurred as long as the legal action against them is defended successfully. Determining which is better for your business (mandatory or discretionary) means you must consider your company’s appetite for risk as well as the type of director or officer you want to attract.
Keep in mind that there are exceptions to the indemnification provisions. If legal action is brought against a director or officer by a shareholder, he or she cannot be reimbursed for any expenses because essentially the company would be paying itself. Also, if the company were to become insolvent, it no longer has the obligation to uphold the indemnification provisions.
Public liability and products liability policies do not cover the cost of D&O legal actions. Settling these legal actions—even if the director or officer is found innocent—can be costly and bankrupt a company or individual. Many companies choose to purchase D&O insurance to protect their executives from legal expenses and personal liability exposures not covered by indemnification.
Assess the D&O policy you have in place and review the policy terms to make sure your limits are high enough to cover legal action against your directors and officers. Also, pay attention to exclusions in your policy, as lawsuits stemming from employment practice are usually not covered. You can count on the insurance professionals at CLA Insurance for the resources and expertise you need to purchase a new D&O policy or update your existing policy today.