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.
What’s the exposure?
Here are some examples: 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 found all the members of an LLC, and sued every member found. Whew!
So, what’s the chance this could happen?
Whenever there are outside shareholders or noteholders, 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.
What is D&O insurance?
[Email readers, continue here…] 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.
Consider completing the package.
Recently, insurance companies have added employee practice liability insurance (EPLI) to the package to address specifically the 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!
Is this required?
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.
I am one of those.
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 all but one of these rather spurious suits (and settled that one outlier to keep my unaffiliated wife out of this swamp), 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 – but for another time.
Images created using DALL-e, prompt: A realistic image of a man serving papers representing a lawsuit upon another younger man and his board of directors, all in business attire without neckties. Use clear background and ragged edges to picture.
Very good advice Dave. I might add that not only should you require this when engaging as a director, but you should recheck that the policy is current and paid up every year. Particularly if a startup is short on cash, CEOs or CFOs may view renewal as discretionary unless they are held to account.
Doug, very good advice. When a company is on the brink and has professional or outside directors and outside shareholders, we sometimes (often) divert some of the very valuable remaining cash to prepay D&O for three years, called a “tail” policy in case the company fails. These are sad events. But remember that early stage companies are fragive. Fifty-percent of these fail within four years.
-Dave