Managing Risk for Directors and Officers

Every decision a company’s directors and officers make has the potential to be scrutinized by clients, employees, shareholders, and other directors and officers. These stakeholders may file a lawsuit 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’re ever involved in a lawsuit for a decision made in the course of performing their regular duties.

As a business owner, it’s important for you to have the proper risk management in place so you can attract talented directors and officers to your company. Here are three things to consider regarding the current risk management strategy at your company.

Corporate Structure

Prior to hiring a new director or officer, review your corporate structure to make sure your practices are sound and secure. You should focus your review on:

• Employee orientation, training and education. Examine the type of training and education you are providing employees and gauge whether it is enough or whether more is needed. Review any incidents that have occurred in the past due to lack of training, and talk to employees to get their feedback on the amount or type of training they receive. Also, make sure your managers are completely aware of the legislation and regulations your company must be in compliance with.

• Internal policies. Do your policies clearly state your ethical standards and what is expected of employees? Legal procedures should be outlined within each policy so employees are aware of the guidelines.

• Liabilities. Review potential liabilities in all areas of the company and the amount of risk each liability poses. This includes reviewing the amount of decision-making power each employee has. In some cases, your directors and officers may have to rely on information from these employees if they don’t have the time to extensively research the details themselves before making a decision. The employees that are tasked with gathering this important information for your managers need to be reliable.

Indemnification Provisions

While reviewing your business’ corporate structure, it’s also a good time to take a look at the indemnification clauses in your bylaws or articles of incorporation. Offered by many companies, indemnification means that your organization will compensate a director or officer for losses incurred during his or her defense in a directors and officers (D&O) lawsuit. It’s important to review your clauses if you haven’t done so in years because the language may no longer be clear and you may have to add to or revise the language if necessary.

The expenses your executives may incur in a D&O lawsuit can be compensated on either a discretionary or mandatory basis. With discretionary indemnification, a company has 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 lawsuit 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 a lawsuit 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.

D&O Insurance

Commercial general liability policies and umbrella policies do not cover the cost of D&O lawsuits. Settling these lawsuits—even if the director or officer is found innocent—can be costly, and can bankrupt a company or an 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 multiple suits against your directors and officers. Also, pay attention to exclusions in your policy, as employment practices lawsuits are usually not covered. You can count on the insurance professionals at Toole Peet Insurance for the resources and expertise you need to purchase a new D&O policy or update your existing policy today.