[wdm_image_effects effect=”no_effect” animation=”slideInLeft” shape=”no_shape” color=”#000″ social=”” title=”Insurance-” description=”Insurance-dice-small” id=”3347″ show=”hover” counter=”0″ size=”medium”/]
I’ve been sued as a board member too many times over the past twenty-five years of board service. Five times. Does that shock you? It does me. Entrepreneurs blaming their board for failures of a fragile, early stage company. Shareholders unhappy over the same loss, reaching out to sue every name available. Employees reaching out to anyone above to redress grievances. In one case, an aggressive lawyer finding all the members of an LLC, and suing every member found. Whew!
Whenever there are outside shareholders or note holders, or unhappy employees, and when there is a product in release, there is a chance, no matter how slight, of a lawsuit against members of the board as well as against the corporation itself. Even if such a suit is completely without merit, the cost of defense and the risk of a negative outcome both hang over the company and the director.
Directors and Officers insurance (D&O) is meant to reduce that risk and provide for the
legal defense of any such suit at the expense of the insurance company. In that regard, even the lowest amount of D&O insurance available, $1 million, provides for legal defense costs to be covered. The usual cost for such insurance is $4 to $6 thousand a year, with an extra $2 thousand for an additional million dollars of coverage.
[Email readers, continue here…] Recently, insurance companies have added employment practice liability insurance (EPLI) to the package to address specifically the recently-increasing risk of employees suing for redress. Given the increasing number of suits for sexual, racial, gender and other discrimination, this now seems logical and necessary. So, add another $3 to $4 thousand to the policy cost. Ouch!
More important than the cost is the provision of investment documents from sophisticated investors like VC’s and sophisticated angels requiring D&O insurance for the company at the time of funding.
Additionally, I have always insisted that a company CEO sign an indemnification agreement, which indemnifies the director in any event of a lawsuit using the full financial resources and staff capabilities of the company. This may sound harsh, but in reality, the insurance obtained does this. However if a policy lapses and is not renewed, and if the directors are not informed, this agreement forms an underlying defense backed by the corporation. Unfortunately, there are times when early stage companies just run out of money and cannot renew their policies and therefore have little resources to pay lawyers for defense of claims. And unfortunately, it is often during these stressful times that shareholders are angered by perceived or actual under-performance by founders and boards.
Over the many years of board service, before insisting upon this insurance requirement before service, I had been sued as a director several times, in no case covered under the umbrella of a D&O policy. Although I won each of these rather spurious suits, the cost of defense in some of the cases was not reimbursed, and the time spent in helping the attorney prepare for the defense and in one case through to a several-day adjudication event, was not small. As a result, I now insist upon D&O insurance for every board upon which I sit. The backgrounds of these suits make for good stories – for another time.
Dave, I also love your periodic postings. I have to agree with you. After 62 corporate boards, mostly early-stage, I am happy to say I was only sued once – but it was a whopper and fully covered. Many times we did not have D&O, but the circumstances were very constrained, and we got it as soon as adequate funding came in. As you said, policies vary. When I once had a policy reviewed it literally only covered one director suing another – that’s it. Not really worth a dime. Use a professional agent. (If you care to include her, mine is Mindy Joslin in San Diego (805) 570-5300)
One area that’s often overlooked is the equally critical need for nonprofit boards to have D&O insurance. Many nonprofit officers / board members of under-resourced nonprofits will say they can’t afford it, but this is a “you can’t afford not to have it” scenario. This post was particularly timely because I personally know of a situation where a co-op pre-school’s board just terminated their head of school in a very clumsy and ill-informed fashion, and I don’t think those board members are aware they could be held personally liable if the terminated employee decides to sue.
I would second the need to read the policy carefully. Some policies only cover directors and officers for legal actions BROUGHT while they are in office, whereas you need one that covers them for events OCCURRING while they are in office, even if they the actions are brought after they leave. I have also seen policies (for companies with little or no US presence) that exclude coverage for anything happening in the US, which could be a problem for a US-based director (they will be the easy target for a US complaint to go after). The US is litigious compared to other countries, and coverage, especially without a US legal entity, can be quite expensive to add.
Want to really protect yourself and the other Board members? Make sure that a good insurance agent from a reputable company is on the Board!
I LOVE getting your emails, Dave. Thanks.
Harley
Note: D & O often does not cover legal fees. Ensure you read each policy carefully before believing you have such coverage. Also, ensuring the board is aware of cash flow management, usually with a 13 week rolling (updated weekly) cash flow forecast can provide a timely alert as to when to resign from a board. (If financial exposure is a big issue to a particular director, especially one who hasn’t yet had some major successes under their belt.). Lastly, relative to the company having the cash to actually indemnify the directors, ensure a financially savvy director conducts an audit and discussion with the company’s “controller”. (I’ve replaced one highly recommended part-time “controller”, who really didn’t understand their job. Also, remember the necessary forecasting of sales and collections requires more experienced art than just a good business education.)
However, in general, Dave’s words of experienced wisdom, resulting from being very awake in many venture situations, through many laps around the sun, is a valuable service to all of us. Thanks, Dave!
Bob,
regarding the coverage of legal fees: Most D&O policies today DO cover legal fees. The best ones do not deduct these fees from the total coverage amount, while many combine legal costs with payout coverage to reach the maximum (after deductible in both cases.) Thanks for your excellent comments!
Dave